How RSUs Are Taxed When They Vest (and the Two Traps That Quietly Cost W-2 Earners Thousands)

Restricted Stock Units are taxed as ordinary income on the day they vest. The full fair-market value of the shares that vest is added to your W-2 in Box 1 — exactly like a cash bonus — whether or not you sell a single share. For a high earner, though, the tax itself is rarely the problem. The expensive part is what your employer doesn't withhold, and a quirk on your brokerage statement that can make you pay tax twice.

Vesting, not granting, is the taxable event

When RSUs are granted, nothing happens for taxes. When they vest, the shares become yours, and that day's closing price multiplied by the number of shares becomes ordinary compensation income. If 1,000 shares vest at $150, you just recognized $150,000 of income — and it's subject to federal income tax, Social Security tax (up to the wage base), the 1.45% Medicare tax, and the extra 0.9% Additional Medicare Tax once your wages clear $200,000.

Trap #1: the 22% withholding gap

Here's the one that ruins Aprils. The IRS lets employers withhold on "supplemental wages" (bonuses and RSUs) at a flat 22% federal rate up to $1 million per year. That sounds fine — until you remember a typical RSU recipient is in the 32%, 35%, or 37% bracket. Your employer withholds 22% while you actually owe 35%. That 13-point gap is real cash you'll have to find next April.

Vest value	Withheld at 22%	Owed at 35%	Shortfall
$150,000	$33,000	$52,500	$19,500
$300,000	$66,000	$105,000	$39,000

Worse, the IRS can add an underpayment penalty on top. The fix is to cover the gap during the year — either through extra payroll withholding, quarterly estimated payments, or hitting a safe harbor (pay in at least 110% of last year's total tax if your AGI was over $150,000, and the penalty disappears regardless of what you owe).

Trap #2: the cost-basis double-tax

This is the one almost nobody catches. When you sell vested shares, your broker issues a 1099-B — and many brokers report your cost basis as $0 or only the (often discounted) amount you paid. But your true basis is the fair-market value at vesting, because you already paid ordinary income tax on that amount.

If you don't correct it, the IRS thinks your entire sale price is a gain and taxes it again. Example: shares vested at $150 (taxed as income), you sell the next week at $152. Your real taxable gain is $2 per share. But a $0-basis 1099-B reports a $152 gain — you'd pay capital gains tax on $150 you already paid income tax on. The cure is to report the correct basis on Form 8949 using the "adjustment" column. On a six-figure vest, catching this is worth tens of thousands.

The behavioral trap underneath both

A vest is economically identical to receiving a cash bonus and immediately buying your employer's stock with all of it. Ask yourself the honest question: if you'd been handed $150,000 in cash, would you put every dollar into a single stock — the same company that also signs your paycheck? Most people say no, yet they hold vested RSUs out of inertia. Selling at vest (when there's little to no gain) is usually the tax-cheapest way to diversify, because the ordinary-income tax is already settled.

A worked example, from vest to sale

Walk through a single vest to see all three traps at once. Priya, in the 35% bracket, has 1,000 RSUs vest at $150 — $150,000 of ordinary income added to her W-2.

• At vest, her employer sells 220 shares to cover the flat 22% withholding ($33,000) and deposits the remaining 780 shares. Her actual federal tax on that income is about $52,500, so she is quietly $19,500 short before the year even ends.
• Six months later she sells the 780 shares at $165. Her real gain is only ($165 minus $150) times 780, or $11,700 — and because she held under a year, it is a short-term gain taxed at 35%, not a long-term gain.
• At tax time, her 1099-B reports the sale with a $0 cost basis, implying a $128,700 gain. Filed as-is, she pays tax a second time on the $150 per share she already paid income tax on. Adjusting her basis to $150 on Form 8949 corrects the gain back to $11,700.

One routine vest produced an under-withholding gap, a short-term gain, and a basis-reporting error — three separate places to overpay or get penalized, from an event most people barely glance at.

Holding is an active decision, not a default

Had Priya sold all 780 shares the day they vested, her capital gain would have been roughly zero (sale price almost equals vest price), and she would have diversified $117,000 into a balanced portfolio with no extra tax. Every day she holds is a day she is choosing concentration in a single stock — the same company that signs her paycheck — over diversification. That can be the right call, but it should be a deliberate one, sized to how much of her net worth already rides on that one ticker. A useful rule of thumb many planners use: decide in advance the maximum percentage of your portfolio you will let any single stock occupy, and sell mechanically back to that line at each vest.

What to actually do

• Plan for the withholding gap before the vest, not after — top up estimated taxes or use the 110% safe harbor.
• Sell-to-cover or sell-to-diversify at vest unless you have a deliberate, tax-aware reason to hold.
• Fix your cost basis on every RSU sale via Form 8949.
• Track the holding clock from the vest date — hold 12+ months and future appreciation is taxed at lower long-term capital gains rates.