RSUs Are Taxed as Ordinary Income at Vest
When RSUs vest and shares are delivered, the IRS treats the value as ordinary income paid in stock.
Taxable Income = Shares Delivered multiplied by Fair Market Value (FMV) on Delivery Date.
Example: If 1,000 RSUs vest at 75 dollars per share, you recognize 75,000 dollars of ordinary income. This occurs regardless of whether you hold, sell, or donate the shares. The income appears on your Form W-2 and is subject to federal income tax, FICA, and applicable state taxes.
Why Many Employees Owe More at Tax Time
Most employers apply the IRS supplemental wage withholding rate, typically 22 percent on the first 1 million dollars of supplemental income. For many employees, especially those in higher brackets, this is not enough.
Example: If your income places you in the 32 percent or higher bracket, withholding at 22 percent on RSU income creates a shortfall you must make up when you file your return. State supplemental withholding may also be lower than your effective rate, further widening the gap.
How to Manage Under-Withholding
There are several ways to avoid year-end tax surprises:
- Adjust Your W-4: Increase withholding on regular paychecks to help cover RSU-related taxes. This is most effective when planned early and when vesting schedules are predictable.
- Make Estimated Quarterly Payments: If adjusting your W-4 is not feasible, quarterly estimated payments help you avoid penalties tied to underpayment.
- Explore Higher Withholding Elections: Some employers allow higher tax withholding on RSU events. If available, this can bring withholding closer to your marginal tax rate.
Remember: withholding is only a prepayment. Your actual tax liability is determined when you file your return.
Three Common Methods for Paying Taxes at Vest
- Net Share Withholding: Your employer withholds and sells a portion of your vested shares to cover taxes. This is the most common and automatic method.
- Sell-to-Cover: Your broker immediately sells enough shares to satisfy the tax obligation. Timing between vest and sale is usually minimal.
- Cash Payment: If you have cash available in your brokerage account, you can pay the tax directly and retain all vested shares.
RSU Tax Events at a Glance
This table provides a high-level overview of how different RSU milestones are taxed.
| Event | Tax Type | Approx. Rate | Key Notes |
|---|---|---|---|
| RSU Grant | None | 0 percent | No tax due at grant |
| Vesting / Settlement | Ordinary Income | Up to 37 percent federal | Plus FICA and state taxes |
| Sell less than 1 year | Short-Term Capital Gain | Ordinary rates | Tax applies to gains above cost basis |
| Sell more than 1 year | Long-Term Capital Gain | 0, 15, or 20 percent | Preferential rates based on income |
Capital Gains: What Happens When You Sell
The Market Value at vest becomes your cost basis. When you sell:
- Selling within 1 year: short-term gain, taxed at ordinary income rates.
- Selling after 1 year: long-term gain, taxed at preferential capital gains rates.
Holding RSU shares can reduce taxes but increases exposure to company-specific risk, so decisions should balance both tax impact and investment strategy.
The Double-Taxation Trap
Brokerages sometimes report RSU cost basis incorrectly, sometimes even as zero on Form 1099-B. If not corrected, you could pay tax twice: once at vest and again on the same value at sale. Always ensure your cost basis matches the FMV reported as income on your W-2. A tax professional familiar with equity compensation can help prevent costly errors.
FICA: Social Security and Medicare
RSU income is generally subject to FICA at vest:
- Social Security: 6.2 percent up to the annual wage base.
- Medicare: 1.45 percent on all income.
- Additional Medicare Tax: 0.9 percent for high earners.
If your salary already exceeds the Social Security wage base, RSU income may only be subject to Medicare taxes.
Plan Ahead: Track Your Vesting Schedule
A clear vesting calendar helps you estimate your annual income and tax bracket, assess withholding sufficiency, plan any estimated payments, coordinate with a tax professional, and consider charitable or diversification strategies. Proactive planning yields far better outcomes than reacting after tax issues arise.
