RSU taxes aren’t overly complicated but they can be significant. According to Uncle Sam, your earnings may have gone up dramatically even if the size of your paycheck didn’t change. That’s a recipe for a surprise tax bill if you haven’t paid attention to your income tax withholding or considered how to offset the boost to your compensation.
Understanding the tax rules and taking a few simple steps to prepare can go a long way in helping you avoid such a surprise.
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How your RSUs are taxed
RSUs are taxed as ordinary income at the time they vest. When you sell the shares, you may owe capital gains taxes, depending on whether you earned a profit on the sale, as well as other factors.
When RSUs are granted, they’re a promise to issue stock at a later date, but whether you actually see those shares depends on meeting certain conditions. That often means waiting until the shares vest over a period of years. (If they’re double-trigger RSUs, you may also have to wait until your company goes through a liquidity event, such as an initial public offering.)
You don’t owe any taxes yet because you technically don’t own the stock during this period. That’s the same reason you can’t make an 83(b) election on RSUs. An 83(b) election allows an equity holder to recognize their future shares as income before they vest, when the value may be lower. But an 83(b) election is only permitted on unvested shares that are your property, such as stock options.
When they vest, ownership transfers to you, and as far as the IRS is concerned, that makes them income. How much you owe on vested shares depends on their value, which is based on how many shares you received and their market value on the vest date.
RSUs are taxed at your marginal income tax rate (the same as your other wages), and your employer must withhold the required taxes. Your company may withhold stock to cover your taxes or you may be required to sell shares. Paying taxes out-of-pocket also may be an option.
When you sell your RSUs, you may owe capital gains tax if you earned a profit on the sale. The actual tax rate depends in part on how long you held the stock. Shares held less than a year are considered short-term capital gains and are treated as ordinary income. Shares held more than a year are considered long-term capital gains, which are generally taxed at a lower rate, depending on your household income.
Good to know:
- This article discusses federal taxes, but you may also need to consider state income taxes, which vary widely. California, for example, has no favorable capital gains rate at the state level, so all gains on RSUs are taxed as ordinary income.
- Net investment income tax, which adds 3.8% to some or all of your capital gains, may also be a factor if your modified adjusted gross income is more than $200,000 (single filer) or $250,000 (married filing jointly). It’s worth looking into especially if your vested RSUs would push you above the threshold for the first time.
So, how much are your RSUs taxed?
Here’s a scenario to show you how RSU taxes play out on a first equity grant.
- You are granted 5,000 RSUs at the time you join a company. The vesting schedule dictates that 25% of the shares will vest per year over four years.
- On your one-year anniversary, 25% of the shares vest, transferring 1,250 shares to you. The stock is worth $24 per share on the vesting date, bringing the total value of your vested RSUs to $30,000.
- When you decide to sell your shares, their value has increased to $26 per share, making them worth $32,500 total. That means $2,500 is considered a capital gain.
- For this example, let’s say your household earnings put you in the 24% federal tax bracket and the 15% capital gains tax rate.
Here’s generally how your shares would be taxed.
What's taxed | Tax rate | |
|---|---|---|
When they’re granted | Nothing. The shares are promised but haven’t yet transferred to you. | Not applicable. |
When they’re vested | The value of the vested shares.
| Marginal tax rate.
|
When they’re sold | The capital gain, or profit.
| Capital gains tax rate.
|
3 steps to get ahead of your tax bill
People getting RSUs or other equity compensation for the first time can be surprised at the way it changes their financial picture, says Ross Anderson, a certified financial planner (CFP) and co-founder of Craftwork Capital in Alexandria, Virginia.
Taxes can play a big role in that. But the impact also may go beyond taxes to “open new doors you didn’t know were open,” Anderson says. So, as you prepare your finances for an upcoming RSU vest, it’s also a good time to assess your finances as a whole. Here are three ways to do that.
1. Check your withholding
When your RSUs vest, they’re considered supplemental income. The IRS sets the default tax withholding rate at 22%. (It’s 37% on supplemental income over $1 million in a year.) But just because it’s the default rate doesn’t mean it’s the right rate for you.
One common problem people run into with RSUs is that their withholding was too low, Anderson says.
“Twenty-two is a good guess,” Anderson says, “But that’s where people get in trouble if they’re just guessing and they don’t actually know what their tax bracket is going to be.”
How much you owe in federal income taxes depends on your household income and other factors. If you’re married and your spouse also earns a paycheck, it’s a good idea to review your withholding together. The IRS’ tax withholding estimator can help you determine if you should change your withholding or make estimated quarterly tax payments.
It’s important to take this step early because it can throw a wrench in other plans, such as how many shares you hold versus sell, and how you use the proceeds of any sale. You may be sorry come Tax Day if you’ve blown your entire RSU windfall on a great vacation.
2. Revisit your investment strategy
If the value of your RSUs is enough to bump you into a new tax bracket — or even if it’s not — consider how you could offset what you owe by being strategic about the types of tax-advantaged accounts you use for investing. That includes retirement accounts, health savings accounts and education savings accounts, among others.
Maxing out these accounts could reduce your federal and/or state tax liability significantly. That could be a new consideration if the RSUs came with your first high-paying job. Often, young earners prioritize saving in a Roth 401(k) or Roth IRA because they’re in a lower tax bracket than they expect to be in during retirement, when they’ll be able to withdraw those funds tax-free. If that’s been the case for you, but RSUs change your situation, it might be time to send more of your pre-tax dollars to retirement savings with a 401(k) or traditional IRA, Anderson says.
If you’re new to tax-efficient investing, you can explore more with our guide. Getting help from a professional, like an investment or tax advisor, can help here, too.
3. Consider your concentrated stock risk
RSUs are a great perk but they come with some risk. Holding unvested shares and vested shares with a company that also pays your wages means that a significant portion of your net worth depends on a single company. You can reduce your concentrated stock risk by selling vested shares and diversifying into other investments.
That may mean that you pay the higher short-term capital gains tax rate. But that’s not always a bad thing. “I try not to do anything exclusively for tax purposes,” Anderson says.
And if you make a plan to sell the shares at or near the fair market value of the stock on the day the shares vested, the impact on your tax bill could be minimal. Take the example from earlier. If your shares are worth $24 each on the day they vest, and it’s ticked up to $24.08 by the time you go to sell, your proceeds would be $30,100, which makes your capital gain just $100. That generates only $24 in tax.
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