Equity Answers for your equity questions
Let’s imagine it's tax season, and you're staring at your W2, wondering how the Restricted Stock Units (RSUs) you've been accumulating fit into this financial jigsaw. Don't worry; you're not alone in this dilemma.
With years of assisting those in the tech industry, Schmidt has helped many clients identify where their RSU income shows up when tax season arrives. It would be easy to think RSUs are different from normal income because it's not considered ‘salary’. However, this is not the case. Here, we break down the key points about reporting RSU income and by the end of this article you will be able to understand the following:
- How and when RSUs convert to taxable income
- Where to report your RSU income
- Your options for covering the RSU income tax
- How to optimize your RSU income
From Vesting to Taxable Income
RSUs turn into taxable ordinary income when they vest and the company stock price determines the fair market value at the time of vesting. For example, if 100 RSUs vest when the stock is valued at $200 per share, $20,000 is added to your taxable income. This amount is reflected on your W2, increasing your overall tax liability.
What you need to remember:
- RSUs aren’t taxed until they vest.
- Vested RSUs = normal, taxable, W2 income
- All typical tax withholdings apply to vested RSU income
RSU Tax Reporting
RSUs are often used as compensation for employees expected to stay with the company for a certain period or to persuade key employees to remain with the company. Upon vesting, RSUs convert into actual stock, which means you receive shares of the company's stock.
When your RSUs vest, they become part of your taxable income, which needs to be reported on your tax return. The key is understanding how and where to report this income to avoid mistakes like double taxation. Below is a breakdown of where RSUs are reported and how they impact your income taxes.
Identifying the Relevant RSU Tax Forms
The relevant tax forms for reporting RSUs include Form W-2, Form 1099-B, and Form 1040. The employer is responsible for reporting the RSUs on Form W-2 and Form 1099-B, and the employee is responsible for reporting the RSUs on Form 1040. The fair market value of the RSUs is included in Boxes 1, 3 (up to the annual Social Security limit), and 5 of Form W-2.
How Are RSUs Reported on W-2?
RSUs are reported on your W-2 form as follows:
- The value of vested RSUs is included in Box 1 as part of your total taxable income.
- Box 14 may specifically list your RSU income.
- The value also affects other boxes on your W-2, including those for state and local taxes.
- RSUs are treated as regular income, so they're subject to FICA taxes (Medicare and Social Security).
In simple terms, when your RSUs vest, they're reported and taxed just like your regular salary on your W-2 form.
Do I Need to Report 1099-B for RSUs?
Yes, you need to report the 1099-B form when you sell shares from your Restricted Stock Units (RSUs). This form helps you account for any capital gains or losses on your tax return. It's important to note that this is separate from the taxes you already paid when your RSU shares first vested. When you sell these shares, you'll face either short-term or long-term capital gains tax, depending on how long you held them. Remember: you pay taxes twice on RSUs - first when they vest, and again when you sell the shares (unless you sell at a loss).
Where To Report RSUs On Your W2 Tax Return
*Form image: fw2.pdf
Pull up your W2 and locate Box 1 and Box 14.
- Box 1: Represents your taxable income, including salary and vested RSU income.
- Box 14: This is where you’ll typically find the specific amount of RSU income listed separately.
Always cross-reference Box 14 with your vesting schedule to ensure accuracy. Consider consulting a tax professional for personalized guidance to navigate potential tax implications.
What Is RSU Gain On a W-2?
The RSU gain on your W-2 reflects the taxable income generated from the value of vested shares, reported in Box 1..png?width=1600&height=1500&name=B2%20(1).png)
Pro-tip: Check your withholding.
Understanding Restricted Stock Units and Tax Withholding
When RSUs vest, employers typically withhold 22% for federal taxes (or 37% if more than $1 million in shares vest). However, this withholding might not fully cover your total tax liability, especially if you’re in a higher tax bracket.
Since the withholding is often a flat rate, you could owe more taxes when you file your return, depending on your overall income for the year. A “sell-to-cover” strategy is often used, where a portion of the shares is sold to cover your tax obligation. This helps reduce upfront tax burdens but may still leave you owing more depending on your tax bracket. It’s important to plan ahead so you’re not caught off guard by a larger-than-expected tax bill come tax season. RSUs are a form of stock compensation and should be considered in the broader context of your equity compensation tax strategies.
Sell-to-Cover Strategy
In this approach, some shares are sold when your RSUs vest to cover taxes.
- When RSUs vest, some shares are automatically sold.
- The proceeds cover your tax obligations.
- You receive the remaining shares.
While convenient, it may not always be sufficient to meet your total tax obligations. If you're in a higher tax bracket, you may need to sell additional shares to fully cover the taxes. Consulting a financial advisor can help you optimize this strategy and prevent surprise tax bills.
By staying mindful of how RSUs are taxed, reported, and withheld, you can avoid common mistakes and plan more effectively for tax season.
Optimize Your RSU Income
Reporting your taxable income is one thing, and optimizing your income is an entirely different thing. Let’s review a few ways to optimize your income.
First, know your vesting schedule. Take time to read through the entire document. Even if it feels overwhelming at first, take your time and take notes or write down any questions you may have or items you don’t understand. Then keep it where you can access it easily so you can make sure you share it with your financial advisor. And those questions that you came up with, direct those to your advisor. This is where some advisors stand tall above others and display tax alpha for clients who receive RSUs.
Next, check your withholdings before tax season arrives. What your company has used to cover the vesting taxes may not be enough, and it’s better to know this earlier so any adjustments needed can be made. Always plan for the tax impact of vesting RSUs. This can quickly bump you into a higher tax bracket, and you will want to know about it ASAP.
Last, consider diversification. Your financial future should not depend too heavily on one company’s stock, but like a healthy meal, it should be well balanced. Selling vested RSUs to reduce concentration may result in capital gains tax, so it’s important to understand the differences between short-term and long-term capital gains tax rates.
Beyond the W2
While understanding your W2 is crucial, it’s just one piece of the larger financial puzzle. As a tech professional, you should also consider:
- How RSUs fit into your overall compensation package
- Strategies for managing concentrated stock positions
- Balancing RSUs with other investment vehicles
- Planning for future career moves and their impact on unvested RSUs
Now may be the time to optimize your financial strategy. Are you making the most of your RSUs? Is your tax strategy as efficient as your latest algorithm? The right financial advisor can help you:
- Analyze the tax implications of your RSU vestings
- Develop strategies to manage your concentrated stock position
- Integrate RSU planning into your broader financial goals
- Navigate the complexities of equity compensation as your career advances
- Consult a tax professional to manage the complexities of RSU-related tax implications
Understanding how RSUs appear on your W2 is just the beginning. The real power lies in leveraging this knowledge to build a robust financial future. At Schmidt Financial Management, we’re fluent in both finance and tech. This unique blend allows us insight into the complex world of technology compensation benefits. So, if you think it’s time to work with a specialist and leave the generalists behind, schedule an intro today.
