RSU Tax Guide

Vesting tax: ordinary income, FICA, and the withholding gap

When RSUs vest, the fair market value of the shares on the vesting date is included in your W-2 wages as ordinary income. This is not optional or deferrable — IRC Section 83(a) treats the receipt of property (shares) in connection with the performance of services as compensation income in the year the property is no longer subject to a substantial risk of forfeiture. For RSUs, the substantial risk of forfeiture lapses at vesting. Unlike stock options, there is no Section 83(b) election available for RSUs because you do not own anything at the grant date — the RSU is a contractual promise, not property.

The income is subject to all employment taxes. Federal income tax is withheld at the supplemental wage flat rate: 22% on the first $1 million of supplemental wages in a calendar year, and 37% on supplemental wages exceeding $1 million (IRC Section 3402(g) and IRS Revenue Ruling 2008-29). Social Security tax (6.2%) applies until the employee reaches the wage base ($184,500 for 2026), and Medicare tax (1.45%, plus the Additional Medicare Tax of 0.9% on wages above $200,000 single / $250,000 MFJ) applies with no cap. State income tax withholding varies by state.

The withholding gap is the most common source of surprise tax bills. An employee in the 32% federal bracket whose RSUs vest receives only 22% federal withholding — a 10-percentage-point gap. On $150,000 of RSU income, that gap is $15,000 in additional federal tax owed at filing, before considering state tax. Employees who also owe the Additional Medicare Tax (0.9%) and the Net Investment Income Tax (3.8% under IRC Section 1411 on the lesser of net investment income or MAGI above $200,000/$250,000) can face a total effective marginal rate of 40%+ on their RSU vesting income. The fix is to make estimated tax payments in the quarter the RSUs vest, or to increase W-2 withholding via Form W-4 for the remainder of the year.

Companies typically satisfy withholding through one of two methods: sell-to-cover (selling enough shares to cover the withholding and delivering the remaining shares to the employee) or net settlement (withholding shares equal to the tax obligation and delivering the remainder). In either case, the full pre-withholding value is included in W-2 income. The shares sold or withheld to cover tax are not a taxable sale event for the employee — they are a withholding mechanism.

RSU vesting triggers ordinary income equal to FMV on the vesting date. Federal supplemental withholding is 22% (37% above $1M). No Section 83(b) election is available for RSUs. (IRC §83(a); IRC §3402(g); IRS Rev. Rul. 2008-29)

Cost basis at sale: holding period starts at vesting, not at grant

After RSUs vest and you receive shares, those shares have a cost basis equal to the fair market value on the vesting date — the same amount that was included in your W-2 income. This is your starting point for calculating capital gain or loss when you eventually sell the shares. The holding period for long-term vs. short-term capital gains treatment also begins on the vesting date, not the grant date.

If you sell the shares more than one year after the vesting date, any gain above the vesting-date FMV is a long-term capital gain, taxed at 0%, 15%, or 20% depending on your taxable income (the 20% rate applies to taxable income above $518,900 single / $583,750 MFJ for 2026). If you sell within one year of vesting, any gain is a short-term capital gain, taxed at ordinary income rates up to 37%. If the stock price has declined since vesting, you have a capital loss — deductible against other capital gains and up to $3,000 of ordinary income per year, with unlimited carryforward.

The critical trap at sale is the 1099-B reporting. Brokers are required to report the sale on Form 1099-B, but the cost basis reported to the IRS is often incorrect for RSUs. Many brokers report $0 cost basis or the grant-date value rather than the vesting-date FMV. If you enter the 1099-B as-is on your tax return without adjusting the basis, you will double-count the RSU income — once as W-2 wages (correct) and again as a capital gain on the full sale proceeds (incorrect). The fix is to report the correct adjusted cost basis on Form 8949 using column (e) for the adjustment amount and code B in column (f) to indicate basis reported to the IRS was incorrect.

For employees who receive RSU vests on multiple dates, each lot has its own cost basis (the FMV on that specific vesting date) and its own holding period. Tracking lots is essential for tax-loss harvesting, identifying long-term vs. short-term shares to sell, and avoiding basis errors. Most brokerage platforms (Schwab, E*Trade, Morgan Stanley) provide supplemental tax documents that show the correct cost basis per lot — use these, not the raw 1099-B.

Cost basis equals FMV at vesting. Holding period for LTCG starts at vesting. Brokers often report incorrect basis on 1099-B — adjust on Form 8949. (IRC §83(a); IRC §1223(1); IRC §1(h); IRS Form 8949 Instructions)

Multi-state allocation: California workday sourcing and departure traps

Employees who work in multiple states during the RSU vesting period face state income tax in each state that claims sourcing rights over the RSU income. The most aggressive state is California, which uses a workday allocation method: the fraction of RSU income taxable to California equals the number of California workdays during the vesting period divided by the total workdays during the vesting period. This applies even if the employee has moved out of California before the RSUs vest.

For example, if an employee receives a 4-year RSU grant while working in California, transfers to New York after 2 years, and the RSUs vest in New York, California will claim 50% of the RSU income (2 years of California workdays out of 4 years total). The employee files a California nonresident return (Form 540NR) allocating 50% of the RSU income to California, and a New York resident return reporting 100% of the income with a credit for taxes paid to California on the allocated portion. The workday allocation must be calculated precisely — California counts actual workdays in the state, not calendar days, and travel days count for the state where the work was performed.

Several states follow California's workday allocation approach for equity compensation, including New York, Massachusetts, and Pennsylvania. Other states use different methods (some source RSU income entirely to the state of residence at vesting). The interaction between states can create situations where the total state tax exceeds what would be owed in any single state, particularly when the departure state has a higher tax rate than the arrival state and the credit-for-taxes-paid mechanism does not fully offset the double taxation.

The departure trap is particularly acute for California: employees who leave California for a no-income-tax state (Texas, Florida, Washington, Nevada) still owe California tax on the California-sourced portion of RSUs that vest after departure. The only way to reduce the California allocation is to have the RSU vesting period include more non-California workdays — which means the allocation naturally declines as time passes after departure, but the first vests after a move will still carry a high California allocation from the years of service performed in the state.

California sources RSU income based on workdays in California during the vesting period, even after the employee departs. Multi-state employees must file in each claiming state. (Cal. Rev. & Tax Code §17951; FTB Pub. 1031; N.Y. Tax Law §631)

Common mistakes and their dollar costs

The four most expensive RSU tax mistakes are the withholding gap, the double-counting trap, failing to track lots, and ignoring NIIT exposure. Each of these is entirely preventable with basic planning.

The withholding gap costs most RSU recipients between $5,000 and $30,000 per year in unexpected tax bills. An employee with $200,000 in RSU vesting income in the 35% federal bracket receives 22% withholding ($44,000) but owes 35% ($70,000) — a gap of $26,000 before state tax. If the employee also owes the 3.8% Net Investment Income Tax (NIIT) under IRC Section 1411 on MAGI above $200,000 (single) or $250,000 (MFJ), the effective federal rate on RSU income rises to 38.8%, and the withholding gap widens further. The solution is to make quarterly estimated tax payments (Form 1040-ES) in the quarter RSUs vest, or to submit a revised W-4 requesting additional withholding.

The double-counting trap occurs when the employee reports the 1099-B sale proceeds without adjusting the cost basis to reflect the vesting-date FMV already included in W-2 income. On $150,000 of RSU income with a same-day sale, reporting $0 cost basis on the 1099-B creates a phantom $150,000 capital gain — double-counting the income and generating up to $55,000 in additional erroneous tax. The IRS will not catch this in the employee's favor; the employee must file Form 8949 with the correct adjusted basis.

Failing to track lots leads to suboptimal tax outcomes when selling shares. If an employee has RSU lots with vesting dates spanning multiple years, some lots may qualify for long-term capital gains treatment (15% or 20%) while others are short-term (up to 37%). Selling the wrong lot — or letting the broker default to FIFO (first in, first out) when specific identification would be more favorable — can cost thousands in unnecessary tax. Specify lots at sale using specific identification and sell long-term lots first when possible.

Finally, RSU recipients with total income above $200,000 (single) or $250,000 (MFJ) are subject to the 3.8% NIIT on the lesser of net investment income or MAGI above the threshold. RSU vesting income itself is not "net investment income" for NIIT purposes (it is W-2 income), but it increases MAGI, which can pull other investment income (dividends, capital gains, interest) into the NIIT. The capital gain on a subsequent sale of RSU shares IS net investment income. Planning around NIIT requires understanding how each component of income interacts with the threshold.

The four costliest RSU mistakes: withholding gap (22% vs. actual bracket), double-counting on 1099-B, failing to track lots, and NIIT exposure above $200k/$250k MAGI. (IRC §1411; IRC §3402(g); IRS Form 8949; IRC §1(h))