Restricted Stock Unit (RSU)

Key Takeaways

• Restricted Stock Units (RSUs) are a form of equity compensation that provide employees with company shares once specific conditions, such as vesting dates or performance goals, are met
• RSUs have a vesting schedule that determines when shares become fully owned, which may depend on continued employment or performance milestones
• The fair market value of RSUs at vesting is treated as ordinary income, meaning taxes are due when shares are delivered to the employee
• Future gains or losses on vested RSU shares are subject to capital gains tax, depending on how long the shares are held before being sold
• RSU taxation can vary based on income level and withholding method, so understanding payroll tax treatment and potential supplemental withholding is important
• RSUs differ from stock options because they always hold value once vested, whereas stock options can expire worthless if the market price falls below the exercise price
• Employers use RSUs to attract and retain talent, aligning employee interests with company performance through long-term ownership incentives
• RSU planning includes decisions about when to sell shares, how to manage taxes, and how RSUs fit within overall retirement and investment strategies
• Understanding RSU vesting and tax implications helps employees make informed decisions about diversification, liquidity needs, and potential tax exposure
• Proper cost basis tracking is essential when selling RSU shares to avoid double taxation, as brokerages often report incorrect or zero cost basis on Form 1099-B, requiring manual adjustment on tax returns
• Discussing RSU strategies with qualified financial or tax professionals can help ensure compliance and maximize long-term benefits

What Is a Restricted Stock Unit (RSU)?

A Restricted Stock Unit (RSU) is a commitment from an employer to grant an employee a specific number of company shares in the future once certain restrictions are lifted. These restrictions usually involve a vesting schedule, which may depend on continued employment or achievement of performance targets. RSUs represent a promise rather than immediate ownership, meaning the shares do not exist until they vest. Once vested, employees receive the company stock and can either hold or sell the shares based on their personal financial strategy.

RSUs are typically awarded to key employees, executives, and high-performing staff as part of equity compensation packages. They serve as a retention tool by aligning an employee's financial reward with the company's long-term success. Unlike stock options, which allow the purchase of shares at a set price, RSUs require no purchase (employees simply receive the shares when vested). This makes RSUs particularly valuable during market downturns because they always retain some value once shares are issued, even if stock prices fall.

The mechanics of an RSU grant include several key components: the grant date, which establishes the number of promised units; the vesting period, during which shares become earned; and the delivery date, when shares are transferred and taxes are due. At vesting, the fair market value of the stock determines how much income the employee reports for tax purposes. Employers often withhold a portion of the shares or cash equivalent to cover income and payroll taxes, creating what is known as "sell to cover."

RSUs also connect to other important financial terms, such as deferred compensation, capital gains, and withholding taxes. Understanding how these pieces fit together helps employees integrate RSUs into broader retirement and investment planning strategies. When viewed as part of an overall financial picture, RSUs can provide both immediate income potential and long-term growth opportunities, depending on how the shares are managed after vesting.

How RSUs Work

Grant and Vesting Process

A Restricted Stock Unit (RSU) begins with a grant, which outlines the number of units awarded and the conditions that must be met before ownership transfers to the employee. The grant date establishes the terms of the award, including the vesting schedule, which sets the timeline for when shares become fully owned. Vesting can occur gradually over time, known as graded vesting, or all at once after a specific period, known as cliff vesting. This process ensures employees remain with the company long enough to earn the value of their shares.

During the vesting period, RSUs remain restricted, meaning employees cannot sell or transfer them until they vest. If an employee leaves the company before vesting, unvested RSUs are typically forfeited. This retention structure helps align employee interests with the company's long-term performance.

Delivery and Share Ownership

Once RSUs vest, they convert into actual shares of company stock. On the delivery date, the company transfers the vested shares into the employee's brokerage account or issues a cash equivalent to the market value of the shares. The fair market value (FMV) on that date becomes the taxable amount reported as ordinary income. At this stage, the shares belong fully to the employee, who can decide to hold them for potential appreciation or sell them immediately to realize gains.

Companies often offer different settlement options, including "net share settlement," where some shares are withheld for taxes, or "sell to cover," where a portion of shares is sold automatically to meet tax obligations. These options simplify the employee's tax payment process and maintain compliance with payroll requirements.

Step-by-Step: Typical RSU Lifecycle

1. Grant Date: Employer issues a written agreement detailing the number of RSUs and vesting terms
2. Vesting Period: RSUs gradually or fully vest over time, depending on employment or performance milestones
3. Delivery Date: Once vested, shares are issued or sold for their fair market value, creating a taxable event
4. Ownership and Decision: Employee decides whether to hold or sell the shares, considering investment goals and diversification
5. Long-Term Management: If shares are held, any later increase or decrease in price results in capital gains or losses when sold

Why the Process Matters

Understanding how RSUs work helps employees plan for both short-term cash flow and long-term investment growth. Each stage, from grant to ownership, affects financial outcomes differently. Knowing when taxes apply and how shares transition from a promise to actual ownership helps individuals align their RSU strategy with broader retirement planning and wealth management goals.

How RSUs Compare to Stock Options

The following comparison reflects common differences discussed in employee compensation and retirement planning education. It helps clarify how Restricted Stock Units (RSUs) differ from Stock Options in structure, taxation, and long-term value.

Tax Implications of Restricted Stock Units (RSUs)

When RSUs Are Taxed

Restricted Stock Units (RSUs) are taxed when they vest, not when they are granted. At the point of vesting, the fair market value of the shares becomes ordinary income, just like wages. This amount is reported on the employee's Form W-2 and is subject to federal income tax, state tax, and payroll taxes such as Social Security and Medicare.

If the company automatically sells some of the vested shares to cover taxes, this is known as a sell-to-cover transaction. While it simplifies the tax process, employees should still track the number of shares sold to understand their after-tax holdings.

How RSU Taxes Are Calculated

At vesting, the fair market value (FMV) of each share multiplied by the number of vested units equals the taxable income. For example, if 200 RSUs vest when the company's stock price is $50, the employee recognizes $10,000 in ordinary income. Employers usually withhold taxes using a flat supplemental rate, which the IRS sets for bonus and equity income. The 2025 federal supplemental rate is 22% for income under $1 million and 37% for income above that threshold.

However, this flat rate might not reflect the employee's true tax bracket. Some may owe additional tax when they file their return, while others may receive a refund depending on their overall income and deductions.

Capital Gains After Vesting

After the RSUs vest and taxes are paid, any further price change is treated as a capital gain or loss when the shares are eventually sold. If the employee sells the shares immediately after vesting, there is little or no capital gain. If they hold the shares for more than one year, the difference between the sale price and the vesting price is taxed at the long-term capital gains rate, which is typically lower than ordinary income tax rates.

This distinction makes timing an important consideration in RSU planning, especially for employees balancing diversification with tax efficiency.

Planning Considerations

Employees can manage RSU-related taxes by understanding their vesting schedule and anticipating how upcoming vesting events affect their income. Keeping a record of each grant's date, number of shares, and FMV at vesting helps track cost basis for future sales. Many employees also work with tax professionals or financial advisors to coordinate RSU sales with other income sources or to offset gains with losses elsewhere in their portfolio.

Withholding Methods Overview

Employers handle RSU tax withholding in several ways. The most common is net share settlement, where the company withholds a portion of the shares to cover taxes and delivers the remainder to the employee. Another common method is sell-to-cover, where shares are sold automatically to generate cash for tax payment. A few companies also offer a cash transfer option, allowing employees to pay taxes separately. Understanding which method applies to your plan helps you estimate how many shares you will actually receive at each vesting event.

State Tax Variations

State and local tax treatment of RSUs varies significantly. For example, California applies a flat 10.23% supplemental withholding rate to RSU income in 2025, which may underestimate the actual tax liability for high-income earners in California's top 13.3% tax bracket. Other states may have different rates or apply their regular income tax rates to RSU income. For employees working remotely or relocating between states, determining which state has the right to tax RSU income can be complex, as some states tax based on work location while others tax based on residence. Consulting a state-licensed tax advisor ensures compliance with both state and local tax obligations and helps avoid double taxation or missed filings.