RSUs Explained: The Tax Surprise Most People Miss
If you get RSUs as part of your compensation, there's a good chance you'll owe more in taxes than what your employer withheld. Most people don't find this out until tax time. Today, I want to break down exactly how RSUs are taxed and why that gap typically exists.
RSUs are one of the most common forms of equity compensation, especially in tech and corporate roles, but they come with some genuinely confusing tax mechanics. Let's dive in.
What Is an RSU?
RSU stands for restricted stock unit. It's a promise from your employer to give you company stock, but it typically comes with a restriction in the form of a vesting schedule.
A simple example: your company offers 1,000 shares to vest over four years, with 250 shares vesting each year. Unlike stock options, you don't have to buy anything. Once shares vest, they're simply yours. But that also means the tax treatment is different, and that's where people get tripped up.
When Are RSUs Actually Taxed?
Here's the key thing to understand: RSUs are not taxed when they're granted. They're taxed on your vesting date.
The moment shares vest, the fair market value on that date is added to your income, taxed just like your salary. It shows up on your W-2 as wages, and it's subject to federal income tax, state income tax, Social Security, and Medicare. This happens whether or not you sell the shares. Even if you hold every single share, you'll still owe tax based on the vesting-date value.
The Withholding Gap
This is the part that catches most people off guard. When RSUs vest, most employers withhold taxes at a flat 22% federal rate. That number sounds official, but it's not based on your unique tax situation. It's just a standard supplemental wage withholding rate.
If your total income puts you in the 24%, 32%, or even 37% tax bracket, there's a good chance that 22% won't be enough to cover what you actually owe. This is the withholding gap, and it's the reason so many people with meaningful RSU income end up with a surprise tax bill come April.
Most companies also use something called sell-to-cover, meaning they sell some of your vested shares to account for that 22% withholding. That can create a false sense that taxes are already handled, when in reality it's often only a partial payment toward what you'll actually owe.
The Second Tax Event: Selling Your Shares
There's another tax event to be aware of, and that's when you sell your vested shares. Any change in value from the vesting price to the sale price is treated as a capital gain or capital loss.
If you sell shortly after vesting, the gain or loss is typically minimal, since the price normally hasn't moved much. If you hold the stock longer and it appreciates, you're looking at either a short-term or long-term capital gain, depending on whether you held it for over a year.
A Few Things Worth Being Aware Of
If you leave your company before your shares vest, those unvested shares are typically forfeited entirely. This is one major reason companies use RSUs, as a retention tool.
It's also worth noting that if you're holding a large amount in one company's stock, that creates real concentration, and it may be worth looking into diversifying. It's common to end up with a large percentage of your net worth tied to one company's stock without fully realizing it happened. And it's not just concentration in the stock, you also depend on that same company for your income.
The Bottom Line
RSUs can be a great part of a compensation package, but the tax mechanics genuinely trip people up. If you're navigating RSU income and want to build a plan around it, feel free to reach out.