Imagine this: your hard work has paid off, and your company has granted you RSUs (restricted stock units) as part of your compensation package.
You’re excited about this opportunity to share in the company’s success. But, a question pops up: how are RSUs taxed?
It’s a common question among employees who receive this form of equity compensation. Let’s break down the ins and outs of how RSUs are taxed so you can approach this financial windfall strategically.
8 Considerations for Understanding How RSUs Are Taxed
- Grant Date: No taxes are due when RSUs are granted because you don’t own the shares yet.
- Vesting Schedule: RSUs typically vest over a period, and you gain ownership of the shares according to the schedule. Taxes are not due until the shares vest.
- Vesting Date: On this date, the RSUs convert into actual company stock, and the fair market value of the stock becomes part of your taxable income.
- Income Tax at Vesting: The value of the RSUs at vesting is treated as supplemental income and is subject to federal income tax, state and local taxes, and payroll taxes.
- Sell-to-Cover: Companies often sell a portion of your shares to cover withholding taxes. Alternatively, you can pay taxes out of pocket, allowing you to keep more shares.
- Short-Term Capital Gains: If you sell the shares within a year of vesting, any profit is considered a short-term capital gain and is taxed at your ordinary income tax rate.
- Long-Term Capital Gains: Holding the shares for more than a year after vesting qualifies the profit as a long-term capital gain, which typically enjoys lower tax rates than ordinary income.
- Section 83(b) Election: Although more applicable to restricted stock awards (RSAs), this election allows you to pay taxes on the stock’s value at the grant date instead of the vesting date, potentially reducing your overall tax liability if the stock appreciates significantly.
Understanding RSUs
Before discussing taxes, it’s essential to understand what RSUs are and how they work. An RSU is a promise from your employer to grant you company stock in the future, often based on a vesting schedule.
Grant Date
This is the day your employer awards you the RSUs. No taxes are due yet because you don’t actually own the shares until they vest.
Vesting Schedule
A vesting schedule outlines when you get ownership of the RSUs. Most of the time, it’s time-based. This means you get a portion of the shares each year you stay with the company.
For instance, a four-year vesting schedule might release 25% of your RSUs annually. You may also see a “double-trigger” RSU. This means the shares only vest after a specific event, like the company going public (IPO), along with meeting the time requirement.
Vesting Date
This marks the important day when the RSUs convert into actual company stock. They become yours to keep and you will need to understand your tax implications.
At this point, how are RSUs taxed comes into play, as they are treated as part of your income?
How are RSUs Taxed at Vesting?
When your RSUs vest, the fair market value of the stock on that day is considered income. This is treated as supplemental income by the IRS.
You’ll likely see this income reported on your W-2, similar to your regular salary, subject to both income tax and payroll taxes. The tax return will reflect this.
For 2023, the federal withholding rate for supplemental income, which includes RSU income, is 22% for amounts up to $1 million, and 37% on income exceeding $1 million, as detailed on American Payroll.
Additionally, don’t forget about potential state and local income taxes. This means a portion of your shares may be automatically sold, known as “sell to cover”, to take care of the withholding requirements. Some companies offer you the option to pay taxes out of pocket. This gives you complete control over the number of shares you want to sell.
However, this approach might mean a large sum of cash coming out of your account. You will need to determine if that is something that you want to do or if you would rather liquidate shares.
How are RSUs Taxed When Sold?
After your RSUs vest, and you have the actual shares, any profit you make when selling them is considered a capital gain. This is the same as selling any other stock you purchased. This would be reported on your tax return.
Short-Term Capital Gains
If you sell the shares within a year of receiving them (vesting date), your gains are short-term capital gains. They are taxed as regular income, so make sure you’re aware of the tax treatment when selling.
For example, if your ordinary income tax rate is 24%, this short-term gain will also be taxed at 24%. Your tax preparation should factor this in.
Long-Term Capital Gains
But, if you hold the shares for more than one year after vesting, any gain you make is a long-term capital gain. These gains usually qualify for more favorable tax rates than your ordinary income tax rates.
| Income Level (2023) | Tax Rate on Long-Term Capital Gains |
|---|---|
| 0% | $0 – $44,625 (Single Filers) or $0 – $89,250 (Married Filing Jointly) |
| 15% | $44,626 – $492,300 (Single Filers) or $89,251 – $553,850 (Married Filing Jointly) |
| 20% | Over $492,300 (Single Filers) or Over $553,850 (Married Filing Jointly) |
The actual rates might change yearly. You can find the current year’s long-term capital gains tax rates and stock options on the IRS website.
Section 83(b) Election: A Special Case
This is more applicable to restricted stock awards (RSAs), which are slightly different from RSUs. The concept is worth understanding. With RSAs, you receive actual shares of stock but with certain restrictions.
This election allows you to pay taxes on the stock’s value when granted, not when vested. This stock grant has implications for your tax situation, so it is important to be aware of it. You need to make this election with the IRS within 30 days of receiving the grant, as specified in 26 CFR 1.83-2.
This might seem counterintuitive, but it can be advantageous if you expect the stock to appreciate significantly. Instead of potentially owing taxes at a higher rate on the increased value at vesting, you pay tax upfront on the lower initial value. The strike price of your stock options can play a role here.
Selling Your Shares
There are different approaches to consider when selling shares received from vested RSUs. These will impact your tax year.
Sell-to-Cover
In this strategy, enough shares are sold to cover the tax liability upon vesting. You keep the remaining shares. It avoids out-of-pocket expenses but potentially reduces your future gains from the stock.
Same-Day Sale
Here, you sell all of the vested shares immediately. Part of the proceeds will cover taxes while you get the remaining cash. You gain immediate liquidity but forgo future gains on the stock.
Cash Payment
Using this approach, you pay your taxes with your own cash instead of selling shares. It lets you keep your stock, but make sure you have the money to do so. This ensures you have enough money to cover the tax deduction.
FAQs about how are rsus taxed
Do RSUs Get Taxed Twice?
Technically, yes. When they vest, their fair market value becomes taxable income. Any profit you make from selling the shares after they vest is taxed again as a capital gain, which could be either short-term or long-term based on the holding period. This impacts your tax year and your tax preparation.
How Much Tax Will I Pay On My RSU?
This depends on a few factors: your income level, tax bracket, the stock’s fair market value on the vesting date, your state’s tax rates, and when you sell the shares (determining whether it’s short-term or long-term capital gain). It will also be dependent upon how much stock you receive and if you owe ordinary income taxes.
Are RSUs Taxed at 40%?
Not necessarily. Your tax situation is unique. They’re taxed based on your marginal tax bracket, similar to your salary income, which can range from 10% to 37% at the federal level in 2023. If your total income, including your salary and RSU income, puts you in the highest tax bracket, then 37% would be the applicable federal income tax rate.
Should You Sell RSUs Right Away?
That’s your call. It depends on several factors, including your personal financial needs, market conditions, your beliefs about the company’s future performance, and your tax planning strategy. The gains rate could play a part in your decision. You may want to seek help from a tax calculator to help you figure this out. You may even want to look at options from companies such as Intuit TurboTax.
Conclusion
Navigating how RSUs are taxed might feel complex. But with a clear understanding of the process, you can develop a strategy that aligns with your personal financial situation and goals.
If you want to ensure you’re planning your RSU taxation accordingly, Seek guidance from tax professionals and incorporate these valuable shares into your broader wealth-building strategy.
