What Happens When My Restricted Stock Units (RSUs) Vest?

Restricted Stock Units (RSUs) have become a common form of employee compensation, offering a stake in the company’s future success. They represent a promise from an employer to grant shares of company stock upon the fulfillment of certain conditions. Understanding the vesting process and its implications is important for employees to manage their finances. This article explains what happens when your RSUs vest, covering ownership transfer, tax consequences, share delivery, and tax reporting.

Understanding RSU Vesting

A Restricted Stock Unit (RSU) is a form of equity compensation representing a right to receive company stock in the future. This right is typically granted upon satisfying specific vesting requirements. These conditions often involve continued employment over a set period, known as a time-based vesting schedule, or the achievement of particular performance milestones.

Vesting is the process by which an employee gains full ownership of these previously restricted shares. Until RSUs vest, the employee does not have full ownership rights, such as voting rights or the ability to sell the shares. Once vesting conditions are met, restrictions are lifted, and the employee gains full ownership. This means the shares are now considered the employee’s property.

Tax Implications at Vesting

When Restricted Stock Units vest, the fair market value (FMV) of the shares on the vesting date is considered ordinary income to the employee. This income, calculated by multiplying the number of vested shares by the stock’s FMV, is subject to various taxes similar to regular wages, including federal income, state income (where applicable), Social Security, and Medicare taxes.

Employers are required to withhold these taxes at the time of vesting. Many companies use a “sell to cover” or “net share settlement” mechanism, where a portion of vested shares is automatically sold to cover the required tax withholding. For federal income tax, a supplemental wage withholding rate is commonly applied. This rate might not cover the employee’s total tax liability, especially for individuals in higher tax brackets, potentially leading to additional tax owed at year-end. Consequently, the employee receives a net number of shares after these taxes have been withheld.

Share Delivery and Management

After vesting and tax withholding, the net shares are delivered to the employee. This typically involves depositing the shares into a brokerage account designated or facilitated by the employer. Employees then gain full ownership rights for these shares, allowing them to manage their holdings.

Upon delivery, employees have immediate options for managing their newly acquired shares. One common approach is to sell the shares immediately to gain liquidity or to diversify their investment portfolio. This strategy can help mitigate concentration risk associated with holding a large position in a single company’s stock.

Alternatively, employees may choose to hold onto the shares, becoming full shareholders. If shares are held, any future appreciation or depreciation in their value will result in capital gains or losses when they are eventually sold. Companies may also have specific policies that could influence the timing of sales.

Tax Reporting Requirements

The income recognized from RSU vesting, which is the fair market value of the shares on the vesting date, is reported on the employee’s Form W-2. This amount is included in Box 1 (Wages, tips, other compensation) and typically in Box 3 (Social Security wages) and Box 5 (Medicare wages). Some employers may also report RSU income in Box 14 of the W-2.

For tax purposes, the cost basis of the vested shares is established as their fair market value on the vesting date. This cost basis is crucial for calculating any capital gains or losses if the shares are sold later. When an employee subsequently sells these shares, the brokerage firm reports the sale proceeds to the IRS on Form 1099-B. Note that Form 1099-B may sometimes report an incorrect cost basis, requiring adjustment on Form 8949. Both the W-2 income from vesting and any capital gains or losses from a subsequent sale must be reported on the employee’s personal income tax return (Form 1040, with capital gains/losses reported on Schedule D).