How Your RSUs Are Taxed in California

Restricted Stock Units (RSUs) are a common form of equity compensation. Unlike traditional stock options, RSUs represent a promise to deliver company shares once specific vesting conditions are met, typically continued employment over a set period. Understanding how these units are taxed is important for individuals residing in California or those with employment ties to the state, given its unique and complex tax regulations. This article clarifies RSU taxation under California state law, helping individuals navigate their tax obligations.

RSU Taxation Fundamentals in California

In California, RSUs are subject to state income tax upon vesting. The fair market value (FMV) of the shares on the vesting date is treated as ordinary income. This amount is added to an individual’s wages and is fully taxable at California’s progressive state income tax rates. For instance, if 1,000 RSUs vest when the company’s stock is valued at $100 per share, $100,000 of income is recognized.

Employers are generally required to withhold California state income tax from RSU income. The mandatory withholding rate is typically 10.23% of the RSU income. While withheld at vesting, this is an estimate. Actual tax liability is calculated based on total taxable income for the year. The amount withheld may be insufficient, particularly for high-income earners, which could result in additional taxes owed when filing the annual return.

California Residency and RSU Taxation

California’s residency rules significantly influence RSU income taxation, especially for those moving into or out of the state. Full-year residents of California are taxed on all RSU income, regardless of where the work was performed or the company is located. If you are a California resident when your RSUs vest, the full fair market value of those shares is subject to California income tax.

For individuals who are part-year residents or non-residents, California applies specific “source” rules to determine the taxable RSU income portion. The state taxes RSU income based on employment performed in California from the grant date to the vesting date. For example, if RSUs were granted while an individual lived and worked in California but vested after moving out of state, California may still claim a portion. The taxable amount is determined by an allocation ratio: workdays in California between grant and vesting date, relative to total workdays during that period.

If a person worked 600 days in California and 400 days in other states during the vesting period of their RSUs, 60% of that RSU income would be taxable by California. This allocation ratio applies even if the individual is no longer a California resident at vesting. RSUs granted after an individual leaves California are generally not subject to this rule. Conversely, if an individual moves out of California and returns before their RSUs vest, 100% of the income may become subject to California tax.

Reporting RSU Income to California

Taxpayers must accurately report RSU income on their California state tax returns. California generally aligns with federal rules for RSU income recognition, treating fair market value at vesting as compensation. However, state tax reporting and calculation are separate. RSU income is typically included as wages on Form W-2, often appearing in Box 14 labeled as “Other” income.

Residents report this income directly on Form 540, the California Resident Income Tax Return. Part-year residents and non-residents use Form 540NR, the California Nonresident or Part-Year Resident Income Tax Return. These individuals also complete Schedule CA (540) or Schedule CA (540NR) to adjust federal adjusted gross income for California-specific income and deductions, including allocated RSU income. This schedule helps determine California-sourced income.

When preparing state tax returns, ensure RSU income is properly allocated based on residency rules. The California-source income reported on Schedule CA (540NR) for non-residents or part-year residents should reflect the percentage of workdays performed in California during the grant-to-vest period. Proper reporting helps avoid discrepancies and issues with the Franchise Tax Board (FTB).

Sale of Vested RSUs and Capital Gains in California

Once RSUs vest and are taxed as ordinary income, they convert into company stock shares. If these shares are held and later sold, any difference between the sale price and the fair market value on the vesting date (the cost basis) is treated as a capital gain or loss for California tax purposes. For example, if RSUs vested at $100 per share and were later sold at $120 per share, the $20 difference per share would be a capital gain.

California does not differentiate between short-term and long-term capital gains, unlike federal tax law. All capital gains, regardless of how long shares were held after vesting, are taxed as ordinary income at the applicable California state income tax rate. Preferential lower federal long-term capital gains rates do not apply to California state income tax.

Capital losses from vested RSU sales can offset capital gains. If capital losses exceed capital gains, up to $3,000 can be deducted against other ordinary income in a tax year. Remaining capital losses can be carried forward to offset capital gains or a limited amount of ordinary income in future tax years.