Restricted Stock Units (RSU) -- Potential to be Double Taxed!

If your employer grants RSUs (Restricted Stock Units) to you, count your blessings. This is a method of rewarding employees for exceptional contributions, loyalty, or just wanting to say “thanks”. However, there are some things that you should know about the way RSUs are treated from an income tax perspective so that you will not be double taxed.

First of all, RSUs are taxed as ordinary income to you, not capital gains. This sometimes confuses people because most of the time stocks and capital gains go together. When your employer grants RSUs to you, there is a restriction associated with them. Usually, the restriction is that you cannot sell the stock until a certain amount of time has passed, aka vesting period. Typically, an employee will vest in a certain percentage of the granted RSUs every year. For example, it could be that your employer granted 400 RSUs to you that proportionally vest over a 4 year period. This means that you will be vested in 100 RSUs every year for the next 4 years. Every year, once the vesting period is passed, two things happen. Your employer will add the value of the RSUs that vested to your income. And, you will be able to sell the vested RSUs.

Large employers usually relegate the RSU transactions to a broker. Your employer might initially set up the account for you, so you can see how many RSU you have, and when they will vest. Once you become vested in the RSUs, your employer will add the value of the RSUs to your income (assuming an 83(b) election was not made). He’s also obligated to withhold taxes from the distribution, usually referred to as backup withholding. If your employer uses a broker to handle the RSUs, he’ll require that just enough of the vested RSUs be sold to potentially cover all income and social security taxes resulting from the vesting. This is known as Sell to Cover. However you can select another option to sell all of the vested RSUs. This is usually referred to as a Same Day Sale. If you elect the Same Day Sale option, post-deductions proceeds are deposited into your cash brokerage account.

Here is an example of how the double taxation can occur. Let’s say your employer granted 1000 RSUs to you last year. You become vested in 250 shares this year. On the day that you become vested, the stock value is $50. Also, let’s say that you setup the Same Day Sale option in the brokerage account. On the day that you become vested, your broker will sell 250 shares of stock on your behalf. The gross amount from the sale is $12,500 (250sh * $50/sh). However, your broker will probably withhold a fee, maybe $100, for executing the transaction. And, your broker will transfer some amount to your employer to help pay the taxes due. Assume the transfer for taxes is 28% of the sale, or $3500. Whatever is left over, $8900 in this case, is deposited into your cash account at the brokerage firm.

Your end-of-year W-2 will show that you received $12,500 of additional income, and it will also show the $3500 of additional tax paid. Also, you broker is going to issue a 1099-B to you, and therein lies the problem. In this example, your broker should report net proceeds of $12,400 ($12,500 - $100 commission). You must report this 1099-B transaction on your income tax. How you handle it is very important. Your cost basis on the transaction is what the stocks sold for, $12,500. So this essentially turns out to be a short term capital loss on your Schedule D. If you fail to report it, the IRS will assume that your cost basis is zero, and will want you to pay the additional income tax, plus interest and penalties. I’ve seen some people report the transaction with zero cost basis because their employer gave them the stock! Ok, it was a gift, but the employer has already added it to your W-2 income. So, be sure and report the correct basis.

If you sell the stock as soon as you become vested, it’s known as a Same Day Sale. But, if you sell just enough shares to cover the estimated taxes due, it’s known as a Sell to Cover.  

Remember, as soon as you become vested in the RSUs, your employer adds their value to your W-2 income and tax is due. So what happens if the value of the stock that you didn’t sell drops? Well, it’s too bad. You’ve already paid taxes on the RSUs, and it doesn’t matter that their value has decreased. In fact, you can’t get any relief until you sell the stock. Then, you can enter a capital loss on your tax return. Notice I said capital loss, not ordinary loss. Although you can use capital losses to offset capital gains, you can only deduct $3000 of capital losses per year.

If the stock price increases, you are in good shape. If you wait more than a year to sell the stock, then you can report the stock sale as a long-term capital gain. Otherwise, it’s a short-term capital gain.

Brycast Financial Planning in Austin Texas --- We Can Help
Income Tax Preparation in Austin Texas
contact: service@brycast.comhttp://www.brycast.com/
Enrolled Agent; Investment Advisor

Employer Matching in Roth 401(k), Roth 403(b) and Roth 457(b) Plans

Most people understand the employer matching concept as it applies to traditional 401(k), 403(b) and 457(b) plans. In these plans, employees make pre-tax contributions and employers make pre-tax matching contributions into the employees’ accounts. Usually, there is vesting period for the employee before he gains access to the employer matching funds. However, employees are always 100% vested in their own contributions.

When it comes to Roth 401(k), Roth 403(b) and Roth 457(b) plans, the mechanics are different. The IRS states that the “Roth” prefix does not create a new plan. Instead, Roth defines the type of contribution being made to the plan. Designated Roth contributions are included in your gross income, unlike non-Roth contributions. However, your employer’s matching contribution goes into a pre-tax account, just like the non-Roth versions of the plan. Here is an example.

Let’s say you make $100,000 per year and you elect to contribute 5% of your salary to your employer provided 401(k) plan. And, your employer matches 100% of your contribution to the plan. So, you contribute $5000 to your account, and your employer matches your contribution, contributing $5000. The total deposit into your account is $10,000. Your employer will report that your salary is $95,000 for the year (W-2 Box 1). When you withdraw the money from your 401(k), you’ll have to pay tax on the entire withdrawal. If that $10,000 grew to $12,000, you would have to pay tax on $12,000.

Using the same facts as before, but you now contribute to a Roth 401(k). Your $5000 contribution goes into your post-tax account, but your employer’s matching contribution goes into a pre-tax account. The total deposit into your account is still $10,000. However, your employer will report that you made $100,000 (W-2 Box 1), instead of $95,000. Also, let’s assume that the $10,000 contribution also grows to $12,000. When you withdraw the $12,000, you will only need to pay tax on $6000, instead of $12,000.

In summary, even though you contribute to a Roth plan, the employer matching contributions are treated as if the plan is non-Roth.

For more information, read the IRS FAQ.

Brycast Financial Planning in Austin Texas --- We Can Help
Income Tax Preparation in Austin Texas
contact: service@brycast.comhttp://www.brycast.com/
Enrolled Agent; Investment Advisor