Tax Treatment of Your Restricted Stock Units (RSUs) - Vesting Can Be Taxing


What You Should Know About Vesting Your RSUs

Restricted Stock Units (RSUs) are a common way for employers, particularly in the technology industry, to attract and retain talent. For the employee, understanding the tax implications of RSUs is vital in maximizing the value of this form of compensation.

Here we look at the key tax considerations for RSUs. If you are interested in the tax treatment for Employee Stock Purchase Plans (ESPP) or for stock options such as Non-Qualified Stock Options (NSOs) or Incentive Stock Options (ISOs), stayed tuned for our subsequent blog posts covering these topics.

RSU Terminology  

Although they may become shares at some stage, RSUs are not shares, nor are they stock options - thus the term “Units.”

When the RSUs are granted to an employee, they will be covered by an agreement, The RSU Award Agreement, which formally sets out the terms of the award. Here you will find:

  • The total number of shares in the award - the Grant
  • How many shares vest and when - the Vesting Schedule                   
  • What requirements need to be met for the RSUs to vest - Single Trigger, Double Trigger and how unvested shares are dealt with should the employee leave the company before all the shares in the Grant are vested

However, you will not find a lot of information on taxation of your RSUs in these documents.

Taxation at Grant of RSUs

The grant of an RSU award has no tax implications for the employee. Note: a section 83(b) election cannot be made on RSUs.

Taxation at Vesting of RSUs

The vesting of RSUs is the major tax point for the employee. On the date the shares vest, the fair market value (FMV) of the vested shares will be taxed as ordinary income through the employee’s W2.

For example, if 2,000 shares vest on June 30, 2022 when the FMV of the stock is $20 per share, then $40,000 will be included as taxable ordinary income (wages) to the employee on the 2022 W2.

The employee will pay tax on this income in all cases but has some flexibility in terms of whether to receive stock or cash – there are usually three options:

  • Receive all 2,000 shares in broker account – employee must write a check to the employer for 22% (federal) of the $40,000 as the employer must account for withholding tax at 22% (federal) on the vesting date. States also impose withholding.
  • Receive no shares and take all cash – employer will withhold 22% of the cash and remit the balance via paycheck to employee.
  • Sell enough shares to pay the 22% withholding and deposit the remaining shares in a broker account – “Sell to Cover Taxes”

Regardless of which option is chosen, the employee pays tax on the full FMV of the vested shares through their W2. However, the employee may owe additional tax if she is in a higher tax bracket than the 22% withholding.

RSUs that vest in the year may also require making estimated payments depending on the Safe Harbor position for the employee.

Taxation after RSUs Vest

For those shares that the employee receives, the FMV now becomes the tax cost basis, and the capital gains tax aging begins from the date the shares vest. The basis may need to be adjusted for any subsequent sale. We often see cost basis of zero for shares which originated as RSUs – this is always wrong and needs adjusted to the FMV at exercise.

If the shares appreciate beyond the FMV at vesting and are held for at least one year, the appreciation is taxed at the long-term capital gains rate. Losses would be capital losses.

Considerations for RSUs

  • The employee is not required to remit an exercise (strike) price to obtain the shares but will have to account for the tax, as ordinary income, at vesting.
  • There is no discretion over when the shares are taxed. When they vest, they are taxable.
  • By contrast, with NSOs and ISOs, the employee can control the timing of the income inclusion by controlling the timing of the option exercise.
  • Electing to receive a vested RSU in stock is equivalent to receiving a bonus check from your employer, paying tax on it and using the remaining cash to buy the stock in your broker account.
  • The real benefit from RSUs is not in their tax treatment but the opportunity to materially participate in the growth of the company without any outlay or capital invested.

Caution: Like anything else, the price of the stock can decline after it vests resulting in a capital loss. This can lead to an unwelcome whipsaw effect where the value up to vest is taxed as ordinary income and the decline after vest does not off-set ordinary income but is rather a capital loss.

If you have further questions related to your employee compensation plan that includes RSUs, please contact BakerAvenue to speak with a tax expert.

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