Restricted Stock Units (RSUs) are our favorite form of equity compensation due to their relative simplicity, but if you’re not careful, you might end up paying taxes twice on them. The purpose of this article is to address the RSU double taxation issue we’ve being seeing constantly with our Tesla, Intuit, ServiceNow clients. We’ve been able to thankfully rescue $100s of Thousands in taxes during our meetings. We’ll do this by briefly discussing why the double tax on RSUs happens, how the double tax on RSUs is supposed to be fixed and share a real example using actual forms so you get a better sense of what we look out for.
Why Does Double Taxation on RSUs Happen?
Double taxation on RSUs occurs because they are taxed at two different times:
- At Vesting: When RSUs vest, they are considered ordinary income, and their value is included in the employee’s wages. This is reported on the employee’s W-2 form, and the employer withholds federal, state, and sometimes local taxes.
- At Sale: When the employee sells the shares, any gain or loss relative to the fair market value at vesting is subject to capital gains tax. This means if the stock has appreciated since vesting, the gain is taxed again, but this time as a capital gain rather than ordinary income.
How is the Double Tax on RSUs Supposed to be Fixed?
To avoid double taxation, employees must ensure that the correct basis is reported when they sell their RSU shares. The basis is the value of the stock at the time of vesting. If this is not correctly reported, the IRS might assume the basis is ZERO, leading to the entire sale amount being taxed as a capital gain.
Here’s how the issue should be addressed:
- Confirm the Basis: Check the value of the RSUs reported as income on your W-2. This amount is the basis for your shares.
The main reason people end up paying tax twice on RSUs is that the correct cost basis for vested RSUs often goes unreported. It may seem surprising, but tax forms sent to the IRS from your brokerage frequently show a cost basis of $0 instead of the actual cost basis of your shares.
RSU shares are classified as “Non-covered Shares,” meaning brokerages are not required to report the cost basis and often choose not to.
When the basis isn’t reported, a mismatch arises between your employer’s payroll records and the information at your brokerage. Here’s an example to illustrate:
RSU Double Tax Issue Due to Incorrect Cost Basis Reporting
At vesting, your company notes that you owe taxes based on the value of the shares at that time. However, when you sell the shares, if the brokerage does not report the correct basis, a discrepancy occurs between the two cost bases (yes, bases is the plural of basis).
If this mismatch goes uncorrected, you will owe taxes on the value at vesting as usual, but you will also owe taxes again on the same value when you sell the shares.
In the example above, you would end up paying an extra $20,000 in taxes if the basis remains incorrectly reported as $0.
Example 2:
Here is an example. Observing the unrealized gain and the meteoric rise of Tesla, it might be easy to assume significant gains. However, upon examining her RSU supplement and manually revising the RSU cost basis, we discovered the client only had around $53,000 in capital gains.
If she had liquidated her entire position, she would have paid $396,022 at a 20% long-term capital gains rate (due to her income), amounting to $79,200 in taxes. In contrast, by recognizing $53,000 at a 15% rate (due to lower income from capital gains and W-2), she owed only $7,950. This strategy saved her over $71,000 in taxes.
- Adjust the 1099-B Form: When you sell your shares, your brokerage will issue a 1099-B form reporting the proceeds from the sale. Often, this form does not include the correct basis. You need to adjust the cost basis on your tax return to reflect the value of the shares at vesting.
- Use Form 8949: On Form 8949, report the sale of your RSUs and adjust the cost basis if necessary. This ensures that only the gain since vesting is taxed as a capital gain, and you do not get taxed again on the income already reported.
A Real Example with Actual Forms
To make this clearer, let’s walk through an example with real forms.
Example:
- Vesting and W-2 Reporting:
- Let’s say you have 100 RSUs that vest on January 1st, 2023. The stock price on that day is $50 per share.
- The value of the RSUs is $5,000 (100 shares x $50). This $5,000 is added to your income for 2023 and reported on your W-2 form.
- Selling the Shares:
- You decide to sell all 100 shares on June 1st, 2023, when the stock price is $70 per share.
- The proceeds from the sale are $7,000 (100 shares x $70).
- 1099-B and Basis Adjustment:
- Your brokerage issues a 1099-B form showing the $7,000 proceeds from the sale.
- However, the cost basis might not be correctly reported as $5,000. If it shows $0 (or is blank), you need to adjust this.
- Form 8949:
- On Form 8949, you report the sale of the 100 shares.
- You adjust the basis to $5,000, showing a gain of $2,000 ($7,000 sale proceeds – $5,000 basis).
- This $2,000 is the amount that should be taxed as a capital gain.
Conclusion
Double taxation on RSUs can be a significant issue if not handled correctly. By understanding why it happens and how to fix it, you can ensure you are not overpaying on your taxes. Always check the basis reported on your tax forms and make necessary adjustments to avoid being taxed twice. For complex situations, consulting with a tax professional can provide additional peace of mind and ensure compliance with IRS regulations.
Ready to take control of your RSU taxation? Book a complimentary consultation with us today to review your strategy. Let us help you ensure you’re making the most of your equity compensation and avoid unnecessary tax burdens. We look forward to assisting you in optimizing your financial future.
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