RSU Taxation
RSU taxation is straight-forward, but also commonly misunderstood. Here's what you need to know!
Tax Implications of RSUs
RSUs typically have the most straightforward taxation amongst the types of stock-based comp. The key tax things one should know are:
When taxation occurs: RSUs are taxed when they vest (no taxation when granted). As a reminder, if RSUs have a double-trigger, shares do not officially vest (and thus a taxable event does not occur) until both triggers are met.
Taxation type (ordinary income): When RSUs vest, the cash flow is taxed as ordinary income. As ordinary income, it is also subject to FICA taxes (Medicare; Social Security) and state taxes (if applicable). If RSUs are held after vesting (instead of fully sold), the gain/loss thereafter will be taxed as a capital gain/loss.
Withholding: Taxes are withheld on RSUs when they vest, but its a bit nuanced:
RSU income is classified as “supplemental wages” (similar to bonuses), which have different withholding requirements. The first $1 million of supplemental wagers are withheld at 22%; above $1 million the withholding rates becomes 37%
FICA taxes will also be withheld when/as applicable: 6.2% for Social Security (if annual max not met) + 1.45% for Medicare + 0.9% Medicare surcharge (if wages exceed threshold)
Most publicly traded companies will auto-sell a portion of your RSUs the day they vest to generate the cash required for withholding (known as "sell-to-cover")
Unique Items and Special Situations
RSU Tax Withholding Is Too Low; You Still Owe the Difference
As "supplemental wages", vested RSU income is very likely withheld by your company (per IRS rules) at the 22% rate. But as ordinary income (e.g. in addition to your salary), most high-income tech workers will owe a much higher rate (typically 32-37%). Key takeaways and considerations of this are:
Expect a (potentially large) tax bill in April. Your company withheld what they were required to (per IRS), but it likely wasn't enough and you owe, and will need to pay, the difference.
This may result in an under-withholding penalty/fee. In some situations, the under-withholding on RSU vesting income is significant enough to result in penalty fees.
Some companies may allow you to elect higher RSU withholding. Your company may offer you the ability to increase your RSU vesting withholding. If not, you always have the option to pay estimated taxes.
There is No Tax Benefit to Holding RSUs After Vesting
A common misconception we frequently hear from clients is "I want/plan to hold my RSUs for at least a year after they vest to get the tax benefits". For all intents and purposes, this is false.
Why the misconception? Some individuals have been told/believe that if they hold shares for 1 year (or more) after RSUs vest, they will get (lower) long-term capital gains treatment instead of (higher) ordinary income tax. This is potentially minorly true (i.e. the misconception), but only on the change in stock price after the RSUs vest (which is identical to how any other stock invested is treated). For example, let's say:
Jenny vests 1,000 shares at $50 a share. This results in:
$50,000 of income generated/triggered on the vesting date
The company sells some shares to cover withholding (e.g. 22% federal + 8% state)
The remaining 700 shares are put into Jenny's account, and have a cost basis of $50
If Jenny then:
Sells all 700 shares at $50 the same day -> No gain or loss occurred; no taxes due
Waits 1 year, then sells all 700 at $50 -> No gain or loss occurred; no taxes due
An IPO May Generate a Large Cash Inflow (and Tax Bill)
Most Pre-IPO companies that grant RSUs issue double-trigger RSUs. By design, these vest when two triggers are met. If you've time-vested into a significant number of RSUs -> when an IPO occurs, the second trigger is met and all of these will officially vest.
Good news: Your shares are now fully vested + liquid, and you can sell them to generate cash (except during lock-up and blackout dates)
Bad news: When the IPO/second trigger occurred, that also triggered taxes being due
Publicly Traded Companies Will Auto-Sell Some RSUs When They Vest
When RSUs vest, the generate ordinary income. And just like wages, your company is required to withhold an IRS-specified percent of those wages. In the case of RSU vesting at a publicly traded--the company will generate the cash for tax withholding by selling a portion of your RSUs the day they vest. This is normal/market standard.
83(b) Elections Are Not Allowed With RSUs
With NSOs and ISOs, early exercise via 83(b) is primarily a company/grant-level decision. But RSUs outright cannot be 83(b) exercised (one of the few ways RSUs differ from RSAs).
[Rare] Single-Trigger RSUs at a Private Company
In rare cases where (1) your company is private, and (2) you have single-trigger RSUs, the tax implications can be challenging. Because your company is not publicly traded, shares are illiquid and cannot be sold on the open market to generate cash to cover the tax obligation.
But taxes (and withholding) are still due when then RSUs vest. For withholding, either (1) the company would purchase a portion of your vested RSUs, or (2) the employee (who may not have the funds) would need to pay it out of pocket.
RSU Tax Examples
Background: Rohit, an employee of NextBigThing (a publicly traded company), just had 1,000 RSUs vest. The stock price on his vesting date was $50 per share
Vest date taxation and sales:
On the vesting date, Rohit realizes $50,000 of taxable income
On the vesting date, the NextBigThing auto-sold 30% (300 shares) to cover withholding taxes (Federal + State + FICA)
The remaining 700 shares were deposited in Rohit's brokerage account (cost basis = price on vesting date = $50 per share). Once deposited, Rohit has the choice of selling immediately (except during blackout dates) or holding some/all for a period of time
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