You might have heard concerns about the taxation of restricted stock units (RSUs) and wondered, “Are RSUs taxed twice?”
In this post, I’ll clarify how RSUs are taxed to dispel any confusion.
Timing of Taxes
When you receive RSUs, they are essentially a promise from your employer to give you company stock once certain conditions are met, typically a vesting period.
Here’s the thing: You don’t owe any taxes when the RSUs are granted to you. Rather, the tax implications kick in when the RSUs vest and you actually receive the shares.
Now, at the time of vesting, the value of the shares you receive is considered ordinary income.
This classification means that the market value of the stock on the vesting date is added to your wages for that year, and you owe taxes on it at your regular income tax rate.
So then, this amount is reported on your W-2 form if you’re an employee, and your employer will withhold taxes just like they do for your regular salary.
Many employers hold back awarded RSUs to pay your taxes.
Taxed Twice?
So then, you don’t get taxed when you receive your grant and when they vest. Initially, you’re only taxed when you grant vest.
Now, the question of being taxed twice also arises when you sell the RSU shares.
Here’s what happens: After the shares vest and you’ve paid income tax on their value, any subsequent change in the stock’s value will be subject to capital gains tax when you sell the shares.
This is a separate event from the initial income tax you paid at vesting.
How so?
Double Taxation Example
Well, suppose you have RSUs that vest when the stock price is $50 per share, and you receive 100 shares.
The value of the shares at vesting is $5,000, which is added to your taxable income for that year.
You’ll pay income tax on this $5,000 based on your tax bracket.
Now, if you decide to sell these shares later, the capital gains tax will come into play. Assume the stock price has risen to $70 per share when you sell them. The new value of your shares is $7,000.
Since you already paid taxes on the initial $5,000 at vesting, the capital gain is the difference between the selling price and the price at vesting, which in this case is $2,000 ($7,000 – $5,000).
You’ll pay capital gains tax on this $2,000 gain.
So then, if you sell the shares more than a year after they vest, you may benefit from the lower long-term capital gains tax rate.
And if you sell within a year, the gain is taxed at the higher short-term capital gains rate, which is the same as your ordinary income tax rate.
Taken together, RSUs are not taxed twice in the sense that the same income is taxed multiple times.
Instead, they are subject to two different types of taxes at different stages: income tax when the RSUs vest and capital gains tax when you sell the shares.
Understanding this distinction helps you plan your finances better and make informed decisions about when to sell your RSU shares to optimize your tax situation.