How RSU Compensation Is Taxed and Reported

Restricted Stock Units (RSUs) are a form of equity compensation companies use to grant employees an interest in company stock. Unlike stock options, an RSU is a promise to deliver shares at a future date, provided certain conditions are met. This method of compensation aligns employee interests with company performance, as the value of the RSUs is directly tied to the market price of the company’s stock.

Key Components of an RSU Grant

An RSU grant begins on the Grant Date, the day the company officially promises the RSUs to an employee. The grant agreement specifies the number of RSUs awarded and the conditions required to receive the shares. This date establishes the terms of the grant but does not confer ownership of the stock.

The Vesting Schedule dictates the timeline for earning the right to the shares, which is typically based on a service period. A common structure is cliff vesting, where an employee becomes 100% vested in all RSUs after completing a specific period, such as one year. If the employee leaves before this date, they forfeit the shares.

Another frequent structure is graded vesting, where ownership is earned in increments over a longer period. For example, a four-year graded vesting schedule might release 25% of the RSUs after the first year of service, with the remaining shares vesting in equal monthly or quarterly installments over the next three years. This approach encourages longer-term employee retention.

Should an employee’s tenure with the company end before their RSUs are fully vested, they will experience Forfeiture. This means any unvested RSUs are returned to the company, and the employee loses all rights to them. The specific terms of forfeiture, including how it is handled in situations like termination or resignation, are detailed in the grant agreement.

The Fair Market Value (FMV) is the price of the company’s stock on a specific day, determined by its closing price on a public exchange. This value is the basis for calculating the taxable income an employee recognizes when their RSUs vest.

Taxation at Vesting

When RSUs vest, their total value is treated as ordinary earned income. This amount is calculated by multiplying the number of vested shares by the stock’s Fair Market Value (FMV) on the vesting date. This income is taxed at the same rates as regular salary and is not eligible for preferential tax treatment.

This income is subject to federal, state, and local income taxes at the employee’s marginal rate. It is also subject to Social Security and Medicare (FICA) taxes. For 2025, the Social Security tax is 6.2% on income up to $176,100, and the 1.45% Medicare tax applies to all earned income, with a potential 0.9% additional tax for high-income earners.

To handle the immediate tax liability, employers use several withholding methods. The most common is the Sell-to-Cover transaction, where the company’s brokerage partner automatically sells a portion of the vested shares. The proceeds are then remitted to tax authorities to cover the estimated withholding.

A similar method is Net Share Settlement. Instead of selling shares on the market, the company withholds a number of shares whose value equals the tax obligation. The employee receives the “net” number of shares remaining after the withholding.

A less common option is to Pay Withholding with Cash, where the employee provides the necessary funds to the employer directly. This allows the employee to retain all vested shares but requires having sufficient cash available to cover the tax bill.

Post-Vesting Share Management

After RSUs vest and taxes are paid, the employee owns the shares as a capital asset. It is important to establish the correct Cost Basis, which is the Fair Market Value (FMV) per share on the vesting date. This value, already taxed as ordinary income, is used to calculate capital gains or losses upon sale to prevent double taxation.

The Holding Period begins the day after the vesting date. This determines if future gains or losses are classified as short-term or long-term, which impacts the tax rate applied when the shares are sold.

When an employee sells the shares, the transaction results in a capital gain or loss. A sale of shares held for one year or less from the day after vesting results in a Short-Term Capital Gain or Loss. Short-term gains are taxed at the employee’s ordinary income tax rates.

If shares are held for more than one year after vesting, their sale results in a Long-Term Capital Gain or Loss. Long-term gains are taxed at lower, preferential rates. For 2025, these rates are 0%, 15%, or 20%, depending on the individual’s taxable income.

Annual Tax Reporting Requirements

The ordinary income from vested RSUs is reported on an employee’s Form W-2. This amount is included in the total wages in Box 1. Employers may also note this income in Box 14 labeled “RSU” or use code “V” in Box 12.

When shares are sold, including in a sell-to-cover transaction, the brokerage issues Form 1099-B. This form reports the sale details. However, the cost basis reported in Box 1e is often incorrect, showing $0 or left blank, because brokers are not required to include the compensation income portion.

Failing to correct an inaccurate cost basis on Form 1099-B can lead to double taxation. To prevent this, the taxpayer must use Form 8949 to report the sale correctly. On this form, you list the sale details from the 1099-B and manually enter the correct cost basis, which is the FMV on the vest date, in column (e).

The totals from Form 8949 are carried over to Schedule D. Reporting the correct cost basis ensures the calculated gain or loss only reflects the stock’s change in value since vesting. For a sell-to-cover transaction on the vesting date, this process should result in a minimal or zero capital gain or loss.