Taxation of RSUs explained

This type of income, such as RSU, often appears on W-2s for clients in cities like San Francisco, New York, Chicago, Los Angeles, Boston, and Austin. With our extensive experience, we have seen various ways these tax effects, especially those related to RSUs, impact returns. Below, we summarize common scenarios. If you have questions, feel free to leave comments, and we will gladly assist.

Q: Will I get double-taxed on my RSUs?

A: No, you won’t face double taxation on RSUs, but you might experience taxes at different times. Here’s how RSU compensation generally works:

• When RSUs vest, they appear on box 14 of your W2 with an “RSU” code. You might also see equity compensation listed in box 12 as code V.
• Upon receiving RSUs, part of them is sold to cover federal and state tax withholdings.
• The total RSU amount appears in your total wages on your W2. Although it seems this should be treated as a capital gain or loss, it is categorized as compensation for services. This treatment allows the employer to deduct it and lets the IRS track your earnings accurately.

Selling RSU and Tax Implications

Once you receive the RSUs, you can sell them. If you sell immediately, the transaction will show up on your 1099 from the broker (e.g., Etrade). For instance, if you sell for $1,000,000 but the Fair Market Value (FMV) at the grant time was $990,000, the $1 million will appear as proceeds on your Etrade statement. However, your cost basis, which was taxed when the shares were granted, might not be shown. Correctly calculating the cost basis is crucial to avoid double taxation. In this case, the capital gain would be $10,000 ($1 million sale price minus the $990,000 basis).

Why Might the Cost Basis Be Missing?

The broker might list your cost basis as zero because they may not have the FMV at the grant time. The FMV represents the taxable income when the shares were granted. Employers might provide data showing the granted amount and FMV, but calculating this basis becomes challenging if you hold the shares longer. Long-term capital gains (held over one year) are taxed at a lower rate (23.8%), while short-term gains are taxed as ordinary income (37%). Therefore, holding these investments for over a year might make sense from a tax perspective if you believe in the company’s future.

Key Takeaway: Always calculate and report your basis to avoid double taxation on federal and state levels.

Q: What happens if I’m granted stock options at a market high, and their value drops before I sell?

A: In this case, you’ll have regular income at the grant time and a capital loss upon sale. This situation results in income on your W2 and a loss on the 1099-B. If the loss is significant, it might exceed your capital gains, limiting your deduction to $3,000 per year on your tax returns, with the remainder carried forward.

Q: I didn’t report my RSU income and received a CP2000 letter. What should I do?

A: This situation is common. The IRS issues a CP2000 letter when items are missing from your return, often due to unreported 1099 information. Taxpayers might mistakenly believe their W2 covers all tax-related aspects for RSUs, only to receive a letter later with a large tax bill. This happens because the IRS assesses tax based on the full sale price reported on the 1099, without accounting for the basis already taxed as regular compensation.

Our Solution:

We can help by preparing a response package for the IRS. This usually includes a formatted letter, relevant return information, and possibly an amended return. Our firm boasts a 98% success rate in resolving these issues on the first attempt. Depending on the case, we may need to recompute Schedule D gains and losses, gather relevant information to substantiate the basis, and write an explanatory letter requesting an adjustment.

Disclaimer: This material is for discussion purposes only and does not constitute tax, legal, or investment advice. For professional advice, please contact us directly at hello@dimovtax.com or use the contact form below.