Restricted Stock Units (RSUs) are a common form of compensation in tech, finance, and other high-growth sectors. While they offer a valuable way to share in your company’s success, their tax treatment can be confusing – and costly if misunderstood.
Whether you’re reporting RSUs on taxes for the first time or trying to avoid an IRS issue like a CP2000 letter, this guide explains RSU taxation clearly and thoroughly.
RSUs can help you build long-term wealth, but only if you understand how they’re taxed at vesting and sale, recognize the risks of double taxation, and plan accordingly.
Below, we break down everything you need to know, from cost basis issues to tax-saving strategies.
What Are Restricted Stock Units and How Do They Work?
Restricted Stock Units (RSUs) are shares of company stock granted to employees as part of their compensation. Unlike stock options, which require you to purchase shares, RSUs are granted at no cost. However, they vest over time, meaning you earn the right to own the shares after meeting certain conditions.
Key Components of RSUs
- Grant Date: The date your employer promises you the RSUs. At this stage, you do not own the shares, and they are not taxable.
- Vesting Date: The date you become the owner of the shares. Vesting schedules vary but are often tied to your tenure or performance.
- Ownership: Once vested, the shares are yours to hold, sell, or manage as you see fit.
While RSUs are straightforward in concept, their taxation depends on multiple factors, including when you sell the shares and how long you hold them.
Types of RSUs and Vesting Triggers
While all RSUs function as a form of stock-based compensation, the way they vest can differ significantly – especially between public and private companies.
Understanding the type of RSU you’ve been granted helps clarify when you actually receive your shares and when taxes become a concern.
Single-Trigger vs. Double-Trigger RSUs
Single-trigger RSUs vest based on one condition – usually time. For example, you might receive 1,000 RSUs that vest over four years, with 250 shares vesting each year. Once a tranche vests, the shares are considered yours, and they are taxed as income based on the fair market value at that time.
Double-trigger RSUs require two events to occur before vesting. This structure is especially common in private companies. Typically, these triggers include:
- Time-based vesting, such as a four-year schedule.
- A liquidity event, like the company going public or being acquired.
Until both triggers are met, even if time has passed, the shares are not considered vested or taxable. This can delay taxation until a public listing, helping employees avoid paying taxes on shares that may not yet be sellable.
Public vs. Private Company RSU Practices
In public companies, RSUs usually have single-trigger vesting tied to tenure or performance. Once vested, the shares are immediately transferable and taxed based on the current market value.
In private companies, RSUs often involve double-trigger structures. While time-based vesting may occur internally, the shares remain unvested – and non-taxable – until a liquidity event happens. This prevents employees from being taxed on illiquid shares they can’t yet sell.
Comparing RSUs, Stock Options, and ESPPs: Key Tax and Vesting Differences
| Feature | RSUs | Stock Options | ESPPs |
|---|---|---|---|
| Ownership Timing | At vesting | At exercise | At purchase date |
| Employee Cost | None | Purchase price required | Shares bought via payroll deductions |
| Taxation at Acquisition | Ordinary income at vesting (FMV) | None for ISOs (may trigger AMT); ordinary income for NSOs | Ordinary income on discount (if above IRS limit) |
| Taxation at Sale | Capital gains on appreciation after vesting | Capital gains on appreciation after exercise | Capital gains based on holding period |
| Vesting Requirements | Time- or event-based | Typically time-based | Usually not required |
| Common Use | Retention and incentive | Growth incentive | Employee ownership at a discount |
How to Avoid Double Taxation on RSUs
One of the biggest challenges RSU holders face is avoiding double taxation. This occurs when the cost basis of your shares is not properly accounted for.
What Is Cost Basis?
The cost basis of your RSUs is the FMV at the time of vesting. This amount has already been taxed as income, so it must be subtracted from your sale proceeds to calculate your capital gain or loss.
Why Double Taxation Happens
Brokerage statements often report a cost basis of $0 for RSUs, as the broker may not know the FMV at vesting. This can lead the IRS to tax the entire sale amount as a gain, resulting in double taxation.
How to Avoid Double Taxation
- Verify your cost basis using your W-2 and vesting statements.
- Manually adjust the cost basis when reporting the sale on your tax return.
- Work with a tax professional to ensure accurate reporting.
RSUs and CP2000 Letters
Receiving a CP2000 letter from the IRS is a common issue for RSU holders. This letter indicates that the IRS found discrepancies in your reported income, often due to incorrect cost basis reporting.
Why It Happens:
- Brokers report $0 cost basis for RSU sales, leading the IRS to assess taxes on the full sale amount.
- Taxpayers may fail to include RSU income from their W-2 or properly adjust their basis.
How to Respond:
- Gather documentation, including your W-2 and vesting records.
- Recalculate your capital gains using the correct cost basis.
- Submit a response to the IRS with a detailed explanation and supporting documents.
How Are RSUs Taxed?
RSUs are taxed in two main stages: at the time of vesting and when you sell the shares. Let’s explore how are RSUs are taxed in detail.
1. Taxation at Vesting
When RSUs vest, the Fair Market Value (FMV) of the shares is considered taxable income. This value is included on your W-2 and is subject to the following taxes:
- Federal Income Tax: Taxed at your ordinary income rate.
- State Income Tax: If applicable, based on where you work or reside.
- Social Security and Medicare Taxes: RSUs are treated as wages and subject to these payroll taxes.
Most employers withhold taxes on your behalf by selling a portion of the shares (known as a “sell-to-cover” transaction). This ensures you don’t face a large tax bill at year-end.
2. Taxation at Sale
When you sell the shares, the gain or loss is taxed as a capital gain. The type of capital gain depends on how long you hold the shares after vesting:
- Short-Term Capital Gains: If you sell within one year of vesting, the gain is taxed at your ordinary income tax rate.
- Long-Term Capital Gains: If you sell after holding the shares for more than one year, the gain is taxed at the more favorable long-term capital gains rate (0%, 15%, or 20%, depending on your income).
Example:
- Vesting FMV: $50,000 (taxed as ordinary income)
- Sale Price: $60,000
- Capital Gain: $10,000
In this case, the $10,000 gain would be subject to either short-term or long-term capital gains tax, depending on how long you held the shares.
What Happens When RSUs Lose Value?
Stock prices can fluctuate significantly after RSUs vest. If the stock value drops below the FMV at vesting, you may experience a capital loss when you sell the shares.
Example:
- Vesting FMV: $50,000
- Sale Proceeds: $40,000
- Capital Loss: $10,000
This $10,000 loss can offset other capital gains or up to $3,000 of ordinary income annually, with any remaining loss carried forward to future years.
Key Considerations:
- If you believe in your company’s long-term prospects, holding onto shares may make sense despite short-term fluctuations.
- Always consult a tax advisor before making decisions based on stock performance.
6 Strategic Tax Planning Strategies for RSUs
To maximize the value of your RSUs and avoid costly surprises, it’s essential to plan your tax strategy around vesting, selling, and overall financial goals.
Below are key tactics – updated with deeper insights and real-world scenarios – to help guide your decisions.
1. Timing Your Sales
Tax Rates & Holding Periods
If you hold your RSU shares for more than one year after vesting, any gain on sale qualifies for long-term capital gains tax rates—typically lower than ordinary income rates. Selling within one year results in short-term capital gains, taxed at your higher income rate.
State Residency Considerations
If you anticipate moving to a state with no income tax (e.g., Texas or Florida), consider deferring sales until after your relocation. This can result in significant tax savings, especially if you’re in a high-tax state like California or New York.
Tax-Year Timing Example
Selling RSUs in December vs. January can shift your tax liability by an entire year. If you expect lower income next year, delaying the sale could push your gains into a lower bracket.
2. Diversification and Risk Management
Holding a large percentage of your wealth in your employer’s stock can expose you to concentrated risk. Many financial advisors recommend limiting exposure to any single stock to 10% or less of your portfolio.
Liquidity Planning
Use RSU proceeds to build cash reserves, fund retirement accounts, or invest in diversified assets. Selling vested shares doesn’t signal disloyalty—it’s a smart move for financial independence and security.
3. Hold vs. Sell: Decision Matrix
| Scenario | Consider Selling | Consider Holding |
|---|---|---|
| High concentration in company stock | ✅ | |
| Need cash for large expense (e.g., down payment) | ✅ | |
| Confident in company’s long-term growth | ✅ | |
| Share price has declined post-vesting | ✅ (for tax loss) | |
| Expect lower income next year | ✅ (for lower capital gains tax) |
Use this framework as a starting point, and consult with a tax advisor for personalized strategy.
4. Withholding Adjustments
RSU income is typically subject to statutory withholding (often 22% for federal taxes). For high earners, this might be too low, resulting in a surprise tax bill.
Check Your Coverage
Review your W-2 to see how much RSU income was withheld. If it’s insufficient, consider making estimated tax payments or increasing payroll withholding to avoid underpayment penalties.
5. Record-Keeping
Good documentation protects you from IRS scrutiny and helps prevent double taxation. Maintain:
- Grant notices and vesting schedules
- Brokerage statements showing FMV at vesting
- W-2 and pay stubs for RSU income
- Tax return copies with cost basis adjustments
Consider keeping a dedicated folder—physical or digital—for all equity-related documents each tax year.
6. Alternative Minimum Tax (AMT) Considerations
RSUs themselves do not trigger AMT, but if you also have Incentive Stock Options (ISOs) or other equity types, exercise timing can affect your total tax bill.
Combined Equity Planning
Coordinate RSU sales with ISO exercises. For example, exercising ISOs early in the year and selling RSUs later might spread taxable income more evenly across years.
Take Control of Your Equity Compensation with Guidance from a Trusted CPA
Understanding how RSUs are taxed is essential for making informed financial decisions. From vesting to sale, proper planning ensures you avoid double taxation and maximize your RSU benefits.
For personalized assistance, contact Dimov Tax today.