RSU Taxes: How Stock Vesting Works and What You Owe

RSU taxes catch more tech workers off guard than almost any other financial event — not because the rules are secret, but because the 22% flat withholding rate used by most employers is far below the actual marginal rate for high earners, leaving a surprise tax bill at April 15. Restricted Stock Units are taxed as ordinary income at the moment of vesting — not at grant, not when sold. If 500 RSUs vest when your employer's stock is at $80/share, you immediately owe income tax on $40,000, whether you sell the shares or not. Understanding when RSUs are taxed, how the withholding works, and what decisions you have after vesting can save thousands annually.

The RSU tax timeline: four events, one that generates income

RSUs have a simple but frequently misunderstood tax structure:

The key insight: the income tax event is the vest date. The fair market value of shares on the vest date (share price × number of shares) is added to your W-2 as ordinary income and taxed at your marginal rate — just like salary. If you are in the 32% federal bracket and 9.3% state bracket (California), you owe 41.3% of the vested value as income tax, immediately, regardless of what happens to the stock price after vesting.

How RSU withholding works: sell-to-cover explained

Most employers handle RSU tax withholding through one of two methods:

• Sell-to-cover (most common): On the vest date, the company automatically sells enough shares to cover the estimated tax liability at the flat 22% federal withholding rate (plus state taxes and FICA). The remaining shares are deposited in your brokerage account. If 100 RSUs vest at $45 and your combined withholding rate is 35%, the company sells 35 shares ($1,575) and deposits 65 shares in your account.
• Net share settlement (share withholding): Instead of selling shares to cover taxes, the company retains a portion of shares to cover the estimated withholding. Functionally identical to sell-to-cover but the company does the selling. More common at larger public companies.
• Cash payment (less common): You pay the tax from other funds and receive the full share count. Allows you to keep more shares but requires cash on hand for a potentially large tax payment.

The 22% gap problem: Federal supplemental wage withholding (which RSU income falls under) defaults to 22% for amounts under $1 million. If you are in the 32% or 37% federal marginal bracket — as many senior tech employees are — you are being withheld at 22% when you actually owe 32–37%. The difference accumulates vest by vest throughout the year and produces a large balance due at tax filing time. Many employees also fail to account for the additional 0.9% Medicare surtax on wages above $200,000 single / $250,000 married.

Fix: adjust your W-4 to request additional federal withholding each pay period, or make quarterly estimated tax payments (Form 1040-ES) after each large vest event. The IRS safe harbor rule (pay 100% of prior year's tax liability, or 110% if prior year income exceeded $150,000) can protect you from underpayment penalties even if you end up owing a large amount.

Cost basis and the holding period decision

Your tax cost basis for RSU shares is the fair market value on the vesting date — the same amount already taxed as ordinary income. This has important implications for the hold-vs-sell decision:

The critical trap: if you hold RSU shares and the stock price falls significantly after vesting, you have already paid income tax on the full vest value ($45/share in the example), and now you have shares worth less than you were taxed on. You can deduct the capital loss, but only at $3,000/year against ordinary income — a very slow recovery of the overpaid tax. Many employees hold RSUs emotionally loyal to the company while the stock falls, creating this exact scenario.

RSU planning: the sell-and-diversify default

Most financial advisors recommend selling RSU shares immediately upon vesting as the default position — unless you have specific reasons to hold. The logic:

• You are already compensated in company stock: Your salary, job security, and RSU grants all depend on the company. Holding shares concentrates your risk in a single employer. Diversifying into index funds separates employment risk from investment risk.
• Selling immediately produces no additional capital gains tax: If you sell at the vest price, your capital gain is $0. You have already paid income tax on the full value — selling immediately captures the full post-tax value.
• Holding requires 12+ months to achieve LTCG rates: The tax benefit of holding (LTCG vs STCG treatment) only applies after 12 months. If the stock falls during that period, you may lose more than you saved in taxes.

The case for holding: if you have strong conviction in the company's growth, can tolerate the concentration risk, and the stock has room to run, holding for 12+ months converts future gains to long-term capital gains rates (0–20%) rather than ordinary income rates (22–37%). For a $40,000 gain on $200,000 in RSUs held 13 months, the tax rate difference at a 32% ordinary rate vs 15% LTCG = 17% × $40,000 = $6,800 in taxes saved.

RSU income and its effect on other taxes

Large RSU vesting events ripple through your entire tax situation:

• IRMAA (Medicare premium surcharge): For retirees or those approaching Medicare, large RSU income in the 2 years before Medicare enrollment can trigger IRMAA surcharges of $594–$4,884/year in additional Medicare premiums. (See the IRMAA guide for details.)
• Net Investment Income Tax (NIIT): RSU income itself is not subject to the 3.8% NIIT (which applies to passive investment income), but capital gains from selling RSU shares after the vest are — if your MAGI exceeds $200,000 single / $250,000 married.
• Additional Medicare Tax: The 0.9% additional Medicare tax applies to all wages (including RSU income) above $200,000 single / $250,000 married. This is in addition to the standard 1.45% Medicare tax already withheld. It is not withheld automatically unless wages alone cross the threshold — the balance is reconciled at tax filing.
• California and other state taxes: California taxes RSU income as ordinary income with no preferential treatment for capital gains. The top California rate of 13.3% applies to RSU income, making California one of the most expensive states for RSU compensation.

Key takeaways

• RSUs are taxed as ordinary income at the vesting date — not at grant, not when sold. The fair market value on vest date × number of shares = W-2 income.
• The default 22% federal supplemental withholding is insufficient for employees in the 32–37% bracket; the underpayment gap accumulates through the year and produces a large April tax bill unless additional withholding or estimated payments are made
• Your cost basis in RSU shares is the vest date FMV; selling immediately produces zero capital gain; holding 12+ months converts any appreciation to long-term capital gains at preferential rates (0–20%)
• The primary risk of holding RSU shares: if the stock falls after vesting, you have paid income tax on the full vest value and can only deduct the capital loss at $3,000/year against ordinary income
• The sell-and-diversify default prevents concentration risk in a single employer and captures the full post-tax vest value immediately; holding requires 12+ months, conviction, and tolerance for stock price decline
• Large RSU vests affect: IRMAA eligibility, NIIT on subsequent capital gains, additional Medicare tax (0.9%), ACA subsidy eligibility, and state income tax in high-rate states

Frequently asked questions

When are RSUs taxed?

RSUs are taxed as ordinary income at the time of vesting — not at grant. When shares vest, their fair market value (FMV on vesting date × number of shares) is included in your W-2 as ordinary income, subject to federal income tax, state income tax, Social Security (up to the wage base), and Medicare tax. You owe this tax whether or not you sell the shares.

How does RSU withholding work?

Most employers withhold RSU taxes using "sell-to-cover" — on the vesting date, the company automatically sells enough shares to cover the estimated tax liability at a flat 22% federal withholding rate, plus state taxes and FICA. The remaining shares are deposited in your brokerage account. The 22% flat rate is often insufficient for high-income employees in the 32–37% bracket — you may owe additional taxes at filing time.

What is the cost basis for RSU shares I keep?

Your cost basis for RSU shares you keep after vesting is the fair market value on the vest date. If 100 shares vest at $45 and you sell 13 months later at $60, your taxable gain is $15/share ($1,500 total), taxed at long-term capital gains rates. If you sell immediately at $45, you have $0 gain. Holding RSU shares concentrates risk in a single employer stock — most financial advisors recommend selling and diversifying.

How do RSUs affect my taxes at the end of the year?

RSU income appears in Box 1 of your W-2 as regular wages — bundled with your salary. The shock often comes from: (1) insufficient withholding at 22% flat rate when your actual bracket is 32%+; (2) large vests pushing income into NIIT, additional Medicare tax, or IRMAA territory; (3) vest events in the final quarter not accounted for in withholding. Review your year-to-date W-2 after every vest event and make estimated tax payments if needed.

What is the difference between RSUs and stock options?

RSUs grant actual shares on vesting — taxed as ordinary income at vest, no out-of-pocket cost, no decision required beyond whether to sell or hold. NSOs (Non-Qualified Stock Options) grant the right to buy stock at a fixed grant price, taxed as ordinary income on the spread (market price minus grant price) when exercised. ISOs (Incentive Stock Options) can be exercised without immediate ordinary income tax but may trigger Alternative Minimum Tax. RSUs are more predictable than options, which expire worthless if the stock never rises above the grant price.