RSU Taxes: How are RSUs taxed?

How are RSUs taxed? The taxes on RSU is different from other forms of equity compensation like stock options. When it comes to RSU taxes, there is no immediate tax liability when a restricted stock unit is awarded. The RSU tax treatment is only applicable when vested and the recipients receive the actual payout of stock shares. It is at this point that the recipient has to report the income based on the fair market value of the stock.

Companies award RSUs as a form of stock-based compensation to incentivize their employees. RSUs are bonuses awarded by companies to remarkable employees as stock rather than cash; though RSUs are taxed as if they were paid in cash.

This equity compensation is a common alternative to stock options, specifically for executives, because of their favorable accounting rules and income tax treatment. RSUs came into vogue in the 90s and early 2000s and are a bit simpler than stock options.

In this article, we will discuss how RSUs are taxed and RSU taxes at vest. But first, let’s look at what RSUs are and how they work.

Related: Types and classes of stocks

Restricted stock units have no transaction or stock pricing, instead, the employer simply commits to giving stock shares to an employee in the company on the condition that certain requirements will have to be met by the employee. This means that RSUs can only be awarded to an employee for fulfilling the performance requirements or for being at the company for a set period of time.

This period of time is known as the vesting period which is the time frame between the grant date of the RSU and the vesting date. The vesting date is the date on which the vesting requirements are satisfied. These periods are usually satisfied by the passage of a stated period of time, the employee’s performance, or the achievement of corporate goals.

Conclusively, RSUs come with conditions that usually include a vesting period before the recipient can receive their award. That is, they are issued to employees through a vesting plan and schedule such that employees get the vested shares when they remain with the company for a certain period of time or achieve certain performance milestones.

How restricted stock units (RSUs) work

RSUs can be awarded to employees on performance benchmarks or vesting schedules. The restricted stock units give employees interest in the company stock but have no tangible value until they vest. They usually vest over several years and it is usually common for an employee to not receive anything until they have been in service at the company for a full year. Many companies have structured the RSU vesting schedules in a way that after 1 year, the RSUs vest 1/4 or 1/5 of the total amount of RSUs granted, and then more RSUs are granted each month as the recipient keeps working for the company.

Once an employee meets the requirements, the company transfers the RSUs either in actual shares of the company or the cash equivalent depending on the actual worth of the stock at that time. An employer may dictate whether to give the recipient the actual stock or the cash equivalent; or, it may be left for the recipient to decide which to take.

RSUs are assigned a fair market value (FMV) when they vest and are considered income once vested. As RSUs vest, the recipient gets their equivalent shares and the value of the restricted stock units on the day of vesting is subject to payroll and ordinary income taxation. In most cases, a portion of the shares is withheld by the company to pay income taxes and the employee then receives the remaining shares which he/she has the right to sell.

RSUs don’t provide dividends to the recipients before they vest, though an employer may pay dividend equivalents that can be moved into an escrow account to help offset withholding taxes, or the dividend equivalents can be reinvested through the purchase of additional shares.

There are upsides to issuing RSUs to employees. Restricted stock units provide an incentive for employees to stay with a company for the long term. It encourages employees to perform well so that the company’s shares increase in value. If an employee chooses to hold their shares until they receive the full vested shares and then, the stock of the company rises, the employee receives the capital gain minus the value of the shares withheld for income taxes and the amount due in capital gains taxes.

Furthermore, with RSUs, the administration costs are minimal for employers. This is because there aren’t actual shares to track and record. Also, RSUs allow a company to defer issuing shares until the vesting schedule is complete, which helps delay the dilution of its shares. RSUs don’t have voting rights until the actual shares get issued to the employee at vesting. Therefore, if an employee leaves before the conclusion of their vesting schedule, they forfeit the remaining shares to the company.

See also: Stock options vs RSU differences and similarities

RSU taxes explained

RSU taxes are different from other forms of compensation like stock options in the sense that the entire value of the employee’s vested stock is counted as ordinary income in the year of vesting. RSUs are taxed when vested; that is, an employee pays taxes on his/her RSUs upon vesting. In many cases, the employer may withhold some of the employee’s RSUs to cover the tax burden. While, in other cases, the employee may be given the option to pay the taxes in cash to be able to receive the full amount of their vested RSUs.

RSUs are taxed as ordinary income, thus, the rate that the recipient may pay can range from 10% to 37%, depending on the recipient’s household income. Also, restricted stock units are subject to withholding for social security taxes and medicare taxes. This will result in another 7.65% in tax liability. In addition, the RSUs may be subject to state income taxes depending on where the recipient lives. For example, the RSU taxes in California which withholds 10.23% as each RSU tranche vests.

Section 1244 of the Internal Revenue Code (IRC) governs the taxation of restricted stocks. Restricted stocks are included in gross income for tax purposes and are recognized on the date that the stocks become transferrable (vesting date).

Unlike employee stock options, RSUs aren’t eligible for the IRC 83(b) election, which allows an employee to pay tax before vesting. RSUs are not eligible because they are not considered to be tangible property by the Internal Revenue Service (IRS).

The RSU taxes at vesting includes federal, social security, medicare, state, and local taxes. The company may offer the employee a choice on how to pay the tax or may have a mandatory method. There are 3 common ways used to cover the RSU taxes. They are:

1. The company tenders the number of shares needed to cover the withholding tax
2. The employee funds withholding tax out of pocket and holds 100% of the vested shares
3. Selling all the vested RSUs, essentially turning it into a cash bonus tied to the company’s stock price

In addition, it is important to have it in mind that even if one has a capital loss on the shares, they will still owe income tax based on the price at vesting. For instance, in an extreme case, wherein the stock of a company drops to zero, the amount the employee is taxed on as income equals his/her capital loss. But since in most cases, income is taxed at higher rates than capital gains (losses), the employee would end up losing money on their bonus.

Related: Incentive stock options tax treatment

The RSU tax treatment is the same as if you were to receive a cash bonus on the vesting date and you then immediately used the cash to buy the company’s stock. For RSU taxes at vesting, the number of shares vesting multiplied by the price of shares will give the  income taxed in the current year. Now, if the shares are held beyond the vesting date, the RSU tax treatment for when the shares are sold would be the sales price minus the price at vesting multiplied by the number of shares to give capital gain or loss.

In the case of cash-settled RSUs, you must pay income tax (IT), universal social charge (USC) and pay related social insurance (PRSI) on the cash payment that you receive. The employer makes the necessary deductions through payroll and pays the tax directly to the Collector-General.

RSU taxes at vesting

At the date of vesting, the recipient is taxed on the current value of the shares and must pay income tax (IT), pay related social insurance (PRSI), and universal social charge (USC) on the market value of the vested shares. The recipient will be charged tax on the vesting date or on the date the shares are passed to them, if earlier. The employer makes the necessary deductions through payroll and pays the tax directly to the Collector-General.

How RSUs are taxed at vesting differs from how they are taxed when the shares are sold. Restricted stock units are fully taxable at the time of vesting. The recipient is taxed on the value of the shares at the time of the vesting. RSUs are subject to ordinary income tax rates plus applicable state income tax and social security taxation. They will be subject to federal income tax up to a maximum rate of 37% on the fair market value of the shares issued to the recipient on the date of vesting.

Also, the recipient may be subject to social security contributions; that is FICA, including Medicare at a rate of 1.45% (no contribution ceiling). Moreso, they are subject to Old-Age, Survivors and Disability Insurance at a rate of 6.2% to the extent of the recipient’s income for the year that has not exceeded the applicable contribution ceiling for the tax year. Furthermore, a recipient will be subject to additional Medicare taxes at a rate of 0.9% on wages (income attributable to vested RSUs) that exceed $200,000 ($250,000 for married couples filing jointly) in the calendar year.

Selling an RSU taxes

You may be liable to capital gain tax (CGT) if you sell your shares upon vesting. Nevertheless, you must report this sale to Revenue, even if no tax is due because your employer will not deduct any tax or report the sale for you.

Upon vesting of RSUs, the recipient can subsequently sell the shares acquired. This makes the recipient subject to capital gains tax. The amount that is taxable will be the difference between the sale price and the fair market value of shares when issued at vesting.

If the recipient decides to hold the acquired shares at vesting for a period of time (less than 12 months) before selling them, then the gains will be taxed as short-term capital gains which are generally taxed at the same rate as ordinary income.

In a situation where the recipient holds the acquired shares at vesting for more than 12 months before selling them, any gain from the sale will be taxed as long-term capital gains at a flat rate of either 15% or 20% depending on the income level and filing status of the recipient.

Short-term gains on RSUs are taxed according to income tax rates. The table below shows the 2022 income taxes rates:

The table below shows the 2022 long-term capital gains tax rates:

How to report RSU on tax return

In order to report the taxable amount, a recipient must subtract the original purchase of the stock or its exercise price from the fair market value of the stock on the date it becomes fully vested. This difference is then reported as ordinary income by the taxpayer. If the stock is sold at a later date from the date of vesting, then the difference between the sale price and fair market value is declared as either a capital gain or loss.

Let’s look at an RSU taxation example to illustrate RSU taxes and how to report RSU on tax returns.

Assume, you were awarded 1,000 shares that vest in April of 2022 and your company’s stock is trading at $10 per share on the vesting date. If you hold the shares, you will owe ordinary income taxes on $10,000 (i.e 1,000 shares vested x $10 per share) of RSU income in 2022. This means on the $10,000 RSU income you will be taxed a 10% federal income tax.

But if you hold the stock for two more years and then sell it for $30 per share, you will have a $20,000 capital gain [i.e ($30 – $10) x 1,000 shares]. This means on the $20,000 capital gain you will be taxed on the long-term capital gains tax rate.

See also: Warrants vs stock options

Related: Exercising stock options and taxes

An overview of multinational RSU taxes

The RSUs of an employee will be subject to tax in consonance with the rules of the country in which the income was earned. A recipient may be subject to foreign tax consequences if the recipient earned income in a foreign country that can be attributable to RSUs.

These taxes usually come in the form of a withholding tax imposed by the local country. The withholding required tax will also depend on the country or countries where the recipient worked between the RSU award date and the date of the vest. Taxes such as national income taxes, state/provincial/municipal/local taxes and/or social taxes may also apply.

In a situation where the recipient works or worked in Vietnam, Morocco, Ireland, Canada, Italy or Spain, the recipient’s employer is required to report 100% of the RSU income and withhold taxes at the highest marginal tax under that country’s withholding tax rate at the RSUs date of the vest.

The recipient’s employer will usually withhold taxes and remit the foreign tax to the local tax authorities on behalf of the recipient. Also, the recipient’s employer may be required to report and withhold social security taxes at the RSUs time of vesting.

In a situation where the recipient works or worked in countries such as the United Kingdom, Vietnam, France, Luxembourg, Romania, Belgium, Germany, Argentina, Malaysia, Slovakia, China, Finland, Morocco, South Africa, Egypt, India, Netherlands, Switzerland, Canada, Austria, and Columbia; the employer of the recipient is required to report and withhold tax on the portion of the RSU income that was earned in that country between the day of grant and the day of the vest.

Now, if the RSUs were granted in or, during the vesting period, that the recipient worked in another country; and the recipient did not reside in that country on the date of the vest, then the award will not be subject to withholding in that country at vest. Nevertheless, the recipient may be subject to reporting and paying taxable income attributable to the RSUs in the applicable country.

Employees from the U.S who accept a transfer to a foreign affiliate of a U.S. corporation face severe tax issues in regard to RSUs. Likewise, foreign employees who come to the United States for short or long-term assignments. If granted RSUs, these employees may be subject to double tax on RSU income. Tax treaties, foreign earned income exclusions, and tax credits may mitigate these harsh tax consequences in some cases.

Also, employees receiving RSUs that work in more than one country must consider the social security tax associated with RSUs. Generally, in a situation where there is no social security totalization agreement between the relevant foreign country and the U.S., a recipient may be required to pay social security taxes to the U.S. and foreign taxing agency.

However, the United States has entered into agreements, called Totalization Agreements, with many countries in order to avoid double taxation of income with respect to social security taxes. Therefore, these agreements must be considered when deciding whether an RSUs recipient is subject to the U.S. Social Security/Medicare tax, or subject to the social security taxes of a foreign country.