Equity comp
RSU taxes: a tech employee's guide to tax on restricted stock units
Restricted stock units are the most common form of equity compensation in the technology industry, and the taxation of RSUs is the single subject we get the most reader questions about. The good news is that the rules are not complicated. The bad news is that the IRS-mandated default withholding produces a tax surprise for most people their first big-vest year. This guide walks the mechanics from grant through sale, with the tax events at each step.
Grant: nothing happens (yet)
When your employer grants you RSUs, no tax event occurs. You don't own shares — you have a contractual right to receive shares in the future, conditional on continued employment and reaching the vest date. There is nothing to report on your tax return at grant, and nothing to do beyond making sure you have the offer letter and grant agreement filed somewhere you can find them.
(This is one of the few clean differences between RSUs and the older form of equity comp, non-qualified stock options. NSOs and ISOs come with their own grant-stage paperwork and, in some cases, election windows. For RSUs, grant is administrative.)
Vest: ordinary income
The day shares vest, two things happen simultaneously:
- The full fair-market value of the vesting shares is reported as ordinary W-2 wages on that day's paycheck. This is identical, from a tax standpoint, to a cash bonus of the same amount.
- To cover the tax withholding due on those wages, the plan administrator sells a portion of the vesting shares back to the company or on the open market. The net shares — what's left after the sell-to-cover — are deposited in your brokerage account.
The fair-market value used at vest becomes the cost basis of the net shares. Any subsequent appreciation or decline is a capital gain or loss measured from that vest-day price.
Why the withholding is usually wrong
RSU income, like all "supplemental wages" under IRS rules, is subject to federal income tax withholding at a default rate of 22% (or 37% on the portion exceeding $1 million in a single year). State and local withholding follows each state's rules. Social Security and Medicare are withheld at the standard rates, with Social Security capped at the annual wage base and Medicare uncapped (plus the additional 0.9% Medicare surtax above income thresholds).
Twenty-two percent is the right answer if you happen to be in the 22% federal bracket. For tech employees with meaningful RSU income, you typically aren't. A senior engineer or product manager whose marginal rate is 32%, 35%, or 37% federal will have:
- 22% federal withheld vs. 32–37% owed → a 10–15 point gap.
- Plus 0–13% state, depending on residence.
- Plus the 3.8% Net Investment Income Tax kicking in on investment income above thresholds (which RSU income can push you over).
- Plus the additional 0.9% Medicare surtax.
The consequence is a five-figure (sometimes six-figure) tax bill due at filing the following spring, often accompanied by an underpayment penalty. The most common reaction the first time it happens is anger — at the employer, the brokerage, the IRS — but no one did anything wrong. The default is structurally too low.
The mechanical fixes
- Add additional federal withholding on Form W-4 (the "Extra withholding" line in Step 4(c)). This is the simplest fix: a flat additional dollar amount per pay period is withheld and applied. Estimate the gap, divide by remaining paychecks in the year, and put that on the form.
- Make quarterly estimated tax payments using IRS Form 1040-ES. Useful when the gap is large or when timing matters. The four quarterly due dates are roughly April 15, June 15, September 15, and January 15 of the following year.
- Increase 401(k) deferrals to reduce taxable income. This doesn't fix the withholding gap directly but reduces the size of it.
- Set the gap aside in cash. Less efficient — risks underpayment penalties, ties up cash that could be invested — but the simplest if the math is straightforward and the bill is months away.
Run a projection in January and again after each large vest. The IRS Tax Withholding Estimator (free, online) is a reasonable tool; tax software in projection mode is better.
Sale: capital gains or losses
Once shares are vested and held in your brokerage account, any further movement in price is a capital event. The basis is the vest-day fair market value (already taxed as ordinary income). The holding period for long-term capital gains treatment starts the day after vest.
- Sell within one year of vest: any gain is short-term, taxed at ordinary income rates (your marginal bracket).
- Sell more than one year after vest: any gain is long-term, taxed at preferential capital gains rates (0%, 15%, or 20% federal depending on income, plus the 3.8% Net Investment Income Tax for higher earners).
- Sell at a loss: the loss can offset other capital gains and, up to $3,000 per year, can offset ordinary income; excess losses carry forward.
Selling at vest produces almost no incremental tax bill, because the share price has barely moved between vest and sale. This is why the most common piece of equity-comp advice is "sell at vest by default" — it doesn't create new tax friction, and it eliminates the concentration risk of holding company stock you didn't actively choose to own.
The 1099-B basis problem
One specific reconciliation problem deserves its own subsection because it costs people real money every tax season. When you sell vested RSU shares, the brokerage issues Form 1099-B reporting the sale to the IRS. Historically, many brokerages report the cost basis on the 1099-B as either zero or the original grant value (which is also zero in the case of RSUs, since you paid nothing for them).
The correct cost basis is the fair-market value on the vest date — the amount that was already taxed as W-2 income. If you import the 1099-B into tax software without correction, the software will calculate capital gains as (sale price − reported basis) when it should be (sale price − vest-day FMV). The result: the same income gets taxed twice — once as W-2 wages, once as capital gain.
The fix: every brokerage that handles employer equity issues a supplemental statement showing the correct basis for each lot. Compare the supplemental statement to the 1099-B before filing. If the basis on the 1099-B is wrong, adjust it on Form 8949 (most tax software handles this — the field is typically labeled "adjusted basis" or "corrected basis").
For employees with multi-year vest histories and many lots, this reconciliation is the single largest source of return-prep errors. Slow down; check every lot.
Tax-planning strategies
Donate appreciated shares directly to charity
If you hold long-term-appreciated RSU shares and donate to a qualified charity (or to a donor-advised fund), donating the shares directly — rather than selling and donating the cash — avoids the capital gains tax on the appreciation entirely while still producing a charitable deduction at fair market value. For employees with both significant unrealized gains and existing charitable giving plans, this is the single highest-leverage tax move.
Tax-loss harvest in down years
Years where the share price is below the vest-day basis create capital losses that can offset other capital gains and, to a limit, ordinary income. The wash-sale rule prevents repurchasing the same security within 30 days, but does not prevent selling at a loss after a vest if the lots vested at higher prices.
Coordinate with bonus and ESPP timing
If you have flexibility in when bonus or ESPP-purchase income is recognized, smoothing income across calendar years can avoid pushing yourself into the next bracket in a single year. This is most useful around year-end planning windows.
What happens when you leave
Unvested RSUs are typically forfeited on departure. Vested shares are yours, sitting in your brokerage account, and continue to be subject to the normal capital-gains rules. The W-2 income from prior years' vests has already been recognized and is final.
One subtlety: if you leave during a year with significant pending vests, work the timing if you can. A vest scheduled for the day after your last day is gone; one scheduled for the week before is yours. Whether you can negotiate either is a separate question, but knowing what's at stake is the first step.
Common mistakes
- Ignoring the withholding gap. 22% federal supplemental is below most senior tech employees' marginal rate. The gap doesn't fix itself.
- Holding past vest by default. The decision to hold concentrated employer stock should be deliberate, not the result of inaction.
- Not reconciling the 1099-B basis. Lets the IRS tax the same income twice.
- Treating each vest in isolation. The aggregate annual income is what determines bracket, deduction phaseouts, and underpayment penalty risk.
- Donating cash instead of appreciated shares. Forfeits the capital-gains-tax benefit of giving the shares directly.
- Using "sell-to-cover" as the only withholding mechanism. The shares the broker sells cover the IRS-default 22% only. The rest of the gap is on you.
Tax law evolves. Verify current brackets, supplemental wage rates, and the Net Investment Income Tax thresholds with the IRS or your CPA before acting on specific numbers in this guide.