When Are Restricted Stock Units Taxed?

Restricted Stock Units (RSUs) are a form of equity compensation used by companies to incentivize and retain employees. An RSU represents a promise from an employer to grant an employee shares of the company’s stock or its cash equivalent once specific conditions are met. This compensation aligns employee interests with company success, as RSU value is tied to the stock price. Understanding the tax implications of RSUs is important for employees, as their taxation differs from traditional cash compensation.

Vesting as the Primary Tax Event

The primary event that triggers taxation for Restricted Stock Units is vesting. Vesting signifies when an employee gains full ownership of RSU shares, making them no longer subject to forfeiture and freely transferable or salable. Before vesting, RSUs are a promise of future shares and are not taxed at the grant date, as they are “substantially non-vested property” under tax law.

Companies establish a vesting schedule that outlines when RSU shares will become fully owned. Common vesting schedules include “cliff vesting,” where all shares vest at once after a specified period, such as one year, or “graded vesting,” where shares vest incrementally over several years. For example, a four-year graded vesting schedule might release 25% of the granted shares each year. If an employee leaves the company before their RSUs vest, they forfeit the unvested units.

The vesting date marks when RSU value becomes taxable income. This is when the restrictions lapse, and the shares become transferable. Until this point, the employee does not own the shares and cannot sell them. This tax event is distinct from the initial grant of the RSUs.

Taxation at Vesting

When RSUs vest, their fair market value (FMV) on the vesting date is treated as ordinary income. This income is subject to federal income tax, state income tax, and payroll taxes, including Social Security and Medicare. The amount of income recognized is calculated by multiplying the number of vested shares by the stock’s FMV on the vesting date. For instance, if 100 shares vest at $50 per share, $5,000 will be added to the employee’s taxable income.

Employers are required to withhold taxes at the time of vesting, similar to how they withhold taxes from a cash bonus. This involves a “sell-to-cover” mechanism, where a portion of the newly vested shares is automatically sold to cover the required tax withholdings. Alternatively, an employee might pay the withholding taxes out of pocket or have cash withheld from other compensation.

The income recognized from vested RSUs is reported on the employee’s Form W-2 for the year in which the vesting occurs. This can result in an increase in an individual’s reported income, potentially pushing them into a higher tax bracket. Even if an employee does not receive cash from the RSU vesting, the value is still considered income and is taxed accordingly.

Taxation After Vesting and Upon Sale

Once RSUs vest, they become actual shares of company stock. The cost basis for these shares is established as their fair market value on the vesting date. This means the amount already taxed as ordinary income at vesting forms the starting point for any future capital gains or losses. For example, if shares vested at $50, that $50 per share becomes the cost basis.

If an employee holds shares after vesting and later sells them, any difference between the sale price and cost basis results in a capital gain or loss. If the sale price is higher than the cost basis, a capital gain occurs; if lower, a capital loss. These capital gains or losses are subject to separate tax rules from ordinary income.

The tax rate applied to capital gains depends on the holding period after vesting. If the shares are sold within one year of the vesting date, any gain is considered a short-term capital gain and is taxed at the individual’s ordinary income tax rate. If shares are held for more than one year after vesting, any gain qualifies as a long-term capital gain, taxed at lower rates. Sales of vested RSU shares are reported to the IRS on Form 1099-B by the brokerage. Employees use Form 8949 and Schedule D to report these transactions.

Modifying Tax Timing with a Section 83(b) Election

A Section 83(b) election allows an individual to alter tax timing for restricted property, such as Restricted Stock Awards (RSAs), by choosing taxation at grant rather than vesting. This election is not applicable to RSUs, as RSUs are a promise to deliver shares, not actual property transferred at grant. However, for eligible restricted stock grants, an 83(b) election means the property’s fair market value at the grant date is included in gross income as ordinary income for that year.

The deadline for a Section 83(b) election is 30 days from the grant date of the restricted property, with no exceptions. The election must be filed with the IRS within this period, often by mailing a written statement or using Form 15620. A copy must also be provided to the employer. By making this election, any appreciation in stock value between the grant and vesting dates is treated as a capital gain upon sale, rather than ordinary income at vesting. This can lead to tax savings if the stock appreciates.

Despite potential tax benefits, there are risks associated with an 83(b) election. If the stock’s value declines after the election, or if the employee forfeits shares by leaving the company before vesting, the taxes paid upfront cannot be recovered. Additionally, the election requires payment of taxes on income that has not yet materialized, which can create a cash flow burden. The decision to make an 83(b) election should be carefully considered, weighing anticipated stock appreciation against these risks.