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As the 2023 tax season approaches, you might find yourself facing a familiar question: How exactly are restricted stock units (RSUs) taxed? RSUs are one of the more straightforward forms of equity compensation, both in terms of understanding and taxation. Yet, there are a few nuances that, if overlooked, could lead to unwelcome surprises. With this in mind, let’s delve into the taxation of RSUs to ensure you’re prepared to navigate this aspect of your income with confidence.
RSUs represent a commitment from your employer to grant you company stock once certain conditions—usually related to your tenure at the company—have been met. Unlike stock options, which offer the right to purchase stock at a specific price, RSUs are a grant of stock that has intrinsic value as long as the stock price is above zero.
The taxable event is not when you initially receive the grant— there’s no tax implication until your RSUs vest, which is when the company fulfills its promise to transfer shares to you. At that moment, the fair market value of the shares you receive is considered taxable income and treated just like your salary or a cash bonus, which means it’s subject to federal and state income taxes, as well as payroll taxes like Social Security and Medicare. This income from RSUs is reported on your paystub at vesting and is also included on your W-2 form at the end of the year. For further details on how RSU income is reported, you might find our previous article “RSUs 101—A Quick Refresher” particularly insightful.
The tax rates that apply to RSU income are the same as those for your regular wage or salary income. RSU income is ordinary income, not capital gains, which means it’s simply added to your regular wage or salary income and taxed at those same rates.
However, because the income from RSUs is classified as supplemental income, like a bonus, your employer is required to withhold income tax at statutory rates, which are fixed by law. Typically, this withholding occurs at two distinct rates: for income above $1 million, the federal withholding is 37%, and for income below $1 million, it's either 22% or combined with regular wages for withholding at the regular rate. This can lead to an under-withholding issue if the RSU withholding rate is lower than your actual tax rate, resulting in additional tax due when filing your return. This common under-withholding problem often catches people off guard, as discussed in our previous article “Should I Pay Cash for RSU Taxes?”
It's important to keep track of your RSU income and the taxes withheld throughout the year. If you anticipate that the amount withheld will not cover your tax liability, it may be smart to make estimated tax payments during the year to avoid any surprises at tax time.
As you’re preparing your tax returns, it’s crucial to pay close attention to your tax reporting statements if you had sales of RSU shares during the year. A common pitfall is paying tax twice on RSU income—a costly mistake that can be avoided with careful review and accurate reporting.
As we’ve noted, when RSUs vest and shares are delivered to you, they’re considered taxable income. The cost basis of these shares, which is essential in determining your tax liability, is the value of the shares at the time you receive them. If you later sell these shares, you’re taxed on the gain, which is the difference between the sale price and the cost basis. However, if you neglect to report the cost basis on your tax return, you could inadvertently pay tax on the full sale price of the shares, not just the gain, effectively being taxed twice on the same income.
To prevent this from happening, ensure that your tax reporting statement, specifically IRS Form 1099-B, accurately reflects the cost basis of the shares sold. If you find that box 1e on Form 1099-B shows a value of $0 instead of the true cost basis, you’ll need to make the necessary adjustments on your tax return. For a more in-depth look at this issue and how to avoid it, refer to the article “Don’t Pay Tax Twice on RSU Sales.”
While RSU taxation is mostly straightforward, it’s important to be aware of the special income tax withholdings that apply and to take steps to ensure you’re not paying tax twice on your RSU sales.
As you finalize tax returns for last year, it’s also the perfect time to look ahead and prepare for the current year. A best practice is to estimate your RSU income for the year based on the vesting schedule and current stock price, and adjust your withholdings accordingly. This proactive step will help you avoid under-withholding and the unpleasant surprise of a large tax bill next year. Stay ahead of the game and ensure your financial planning is on track by revisiting your RSU strategy and tax withholdings regularly.
Be sure to revisit our other popular articles for more insights into RSUs and tax strategies:
Parkworth Wealth Management provides holistic wealth management services including financial planning, equity compensation planning, investment management, tax planning, and others, on a fee-only basis and as a fiduciary, acting in clients’ best interests. If you want help properly managing your RSUs and using them to build wealth, schedule a complimentary consultation.
