Tax Implications of Restricted Stock Units (RSUs)

February 22, 2025

Restricted Stock Units (RSUs) are a widely used form of equity compensation provided by employers. Unlike stock options, RSUs do not require an upfront purchase. Instead, they convert into company shares upon vesting, meaning you acquire them gradually or after meeting specific conditions. While RSUs offer significant financial benefits, their tax implications can be complex, particularly in high-tax states such as California.

Key Taxation Events for RSUs

RSUs are taxed at two main points: when they vest and when they are sold.

1. Taxation at Vesting

When RSUs vest, the IRS considers their fair market value (FMV) on the vesting date as taxable income. This income is reported on your W-2 and subject to federal, state (e.g., California), and payroll taxes, including Social Security and Medicare.

Tax Withholding at Vesting

Most employers automatically withhold taxes by selling a portion of your vested shares through a process called "sell-to-cover." Most companies will use the flat IRS withholding rate for supplemental wage income to withhold federal taxes for vested RSUs. This rate is 22%, and rises to 37% for supplemental income over $1 million. In California, a 10.23% state income tax withholding applies (for tax year 2024), in addition to federal withholdings. However, these rates may not fully cover your total tax obligation if you fall into a higher tax bracket. For instance, California’s highest marginal tax rate reaches 13.3%, meaning high earners may need to make additional withholdings or estimated payments to avoid unexpected tax bills.

The FMV at vesting establishes the cost basis, which is used to calculate capital gains or losses when the shares are later sold.

Example:

If 100 shares vest at a stock price of $50 per share, your taxable income is $5,000. The employer withholds:

  • 22% Federal Tax: $1,100 (resulting in the sale of 22 shares: $1,100 / $50 per share)
  • 10.23% CA State Tax: $511.50 (resulting in the sale of 10.23 shares: $511.50 / $50 per share)

You retain 67.77 shares after withholding (100 - 22 - 10.23 = 67.77 shares).

Required Documents for Tax Filing for Vested Shares:

  • RSU Grant Agreement – Outlines the number of shares, vesting schedule, and tax withholding process.
  • Brokerage or Payroll Statement – Provides the FMV of shares on the vesting date.
  • W-2 Form – Includes RSU income in Box 1 (Wages) and details federal and state tax deductions.
  • Tax Withholding Confirmation – Confirms the amount withheld by the employer.

2. Taxation at Sale of RSU Shares

When you sell RSU shares, any profit (appreciation beyond the cost basis) is subject to capital gains tax. The amount you owe depends on how long you hold the shares before selling.

  • Short-Term Capital Gains (Held <1 Year): Taxed at ordinary income tax rates—up to 37% federally and 13.3% in California.
  • Long-Term Capital Gains (Held >1 Year): Taxed at lower federal rates (0%, 15%, or 20%), but California treats all capital gains as ordinary income (up to 13.3%).
  • Sales must be reported using IRS Form 8949, Schedule D, and California Schedule D (if applicable).

Example:

If you sell your 67.77 shares at $60 per share one year after vesting, the profit is $10 per share, totaling $678 ($10 x 67.77 shares).

  • If held for over a year, the federal tax might be 15% (depending on your bracket).
  • In California, the gain is taxed as ordinary income at rates up to 13.3%, regardless of the holding period.

Required Documents for Tax Filing for Capital Gains:

  • Brokerage Trade Confirmation – Details sale price and transaction date.
  • 1099-B Form – Reports the sale proceeds to the IRS.
  • Cost Basis Records – The FMV of RSUs at vesting, essential for calculating capital gains or losses.

California-Specific Tax Rules

  • Double Taxation Risk: If you leave California after RSUs vest, the state may still tax the income based on where the vesting period work was performed.
  • Withholding Shortfalls: The 10.23% state withholding rate may not fully cover your liability, especially for high-income earners.

Tax-Efficient Strategies for RSUs

  • Adjust Withholdings: Increase state tax withholdings or make estimated quarterly payments to avoid underpayment penalties.
  • Hold Shares for Federal Long-Term Gains: Although California taxes all capital gains as ordinary income, federal rates are lower for long-term holdings.
  • Document Work Sourcing: If relocating, keep records of work performed in California during the vesting period to dispute double taxation claims.
  • Diversify Investments: Selling shares periodically can help reduce concentration risk and manage tax liabilities effectively.

Understanding the tax implications of RSUs ensures better financial planning and avoids unexpected tax burdens. Consider consulting a tax professional for personalized advice based on your income and location. At Bing Luo CPA, we are committed to providing expert guidance to help you make well-informed decisions.