Avoid an RSU Double Tax
Restricted Stock Units (RSUs) are one of our favorite forms of equity compensation because they’re relatively simple to understand, but you can easily pay taxes twice on your RSUs if you’re not careful.
When we warn that you can end up paying double taxes on your RSUs, we’re not saying that this problem happens because it’s supposed to happen, but rather because of an error that commonly occurs when completing your tax returns. It may not seem like a huge deal, but RSUs being double taxed can result in paying tens of thousands of dollars in extra taxes!
The purpose of this article is to address this RSU double taxation issue. We’ll do this by discussing why the double tax on RSUs happens, how the double tax on RSUs is supposed to be fixed, and share a real example using actual forms so you get a better sense of what to look out for.
What Causes the RSU Double Tax?
There are four primary causes/reasons why people end up paying tax twice on their RSUs. There are others, but these four are the ones we see most often.
Cause #1 of RSU Double Tax - Cost Basis Establishment
RSUs are typically taxed at two points in time.
At vest
At sale
At vest, your RSUs are treated as wages and get taxed as ordinary income.
At sale, your RSUs are taxed as capital gains or treated as capital losses.
Since RSUs are taxed at vest, it doesn’t matter what the RSUs were worth when they were first granted. All that matters is the value of your RSUs at vest.
It’s at vest that you pay taxes on the full amount of your RSUs and officially establish your stock position in that company.
If you have 2,000 RSUs worth $100k at vest, then your total cost basis on those shares will be $100k ($50/share) because that’s what you’re going to owe taxes on. Here’s what that would look like:
Again, it’s worth repeating that even if you received these RSUs when the company was worth $10/share, all that matters for tax purposes is the value of your RSUs once they vest because this is what establishes your cost basis.
Cause #2 of RSU Double Tax - Reporting of Cost Basis
The biggest cause of people paying tax twice on RSUs is that the correct cost basis on your vested RSUs often does not get reported.
This seems crazy, but the tax forms that go to the IRS from your brokerage will often show a cost basis of $0 rather than the actual cost basis of your shares.
Shares from RSUs are considered “Non-covered Shares” which means that the brokerage doesn’t have to report the cost basis, so they opt not to.
When the basis isn’t reported, there’s a mismatch between what happens through your payroll at your employer and what’s happening at your brokerage. Here’s an example of what we mean:
At vest, your company tracks that you’ll owe taxes based on the value at vest.
At sale and at the brokerage where the shares are held, if no basis gets reported there’s a mismatch between the two cost bases. (Yes, bases is plural for basis.)
If this happens and goes uncorrected, you’ll owe taxes as usual at the time of vest, but you’ll owe taxes again on that same portion of value you already paid taxes on!
In the example above, you’d be paying an extra $20k in taxes if the basis remains uncorrected at $0.
Cause #3 of RSU Double Tax - Tax Form Difficulty
One of the reasons why catching incorrect cost basis is difficult is because the tax forms aren’t the easiest to interpret - especially for non-tax accountants.
The transactions from sales of RSUs and ESPP shares get reported on a 1099-B. Here’s what the totals summary on one of the forms looks like:
(Tax forms are so fun to stare at, aren’t they?!)
Sales from RSUs are categorized into two sale types, Short-term Non-covered and Long-term Non-covered. The “Non-covered” means that the cost basis was not reported to the IRS.
See if you can find the two spots on the form which show sales of stock from RSUs.
(We’ve highlighted them below if you want to cheat.)
As you can see in the totals on the 1099-B, it appears that some cost basis is missing.
The remainder of the 1099-B shows the details of where the totals are coming from. Here’s a detailed look at the Short-term Non-covered Transactions:
As you can see, the $2,123.49 total does not have a cost basis attached. If it is left unchanged, there will be a reported gain of $2,123.49 and you will owe taxes on that amount!
Cause #4 of RSU Double Tax - Tax Software Entry Errors
The last cause/reason people pay tax twice on RSUs is because tax filing software makes it pretty easy to miss.
When you’re doing your taxes, the tax forms can be pretty confusing. And if you’re not used to doing taxes, it’s unlikely that you’ll feel completely confident that what you’re doing is 100% accurate.
In most tax preparation software, there will be a question that asks something to the effect of “Do you have adjustments to this investment sale?”
If you aren’t aware that paying double tax on RSUs is a possibility, it’s very easy to answer “No” to this question since “No” seems like a rational response, but you really should be answering “Yes.”
How to Fix the RSU Double Tax
If the basis on the shares from your RSUs is incorrect on your 1099-B, the best way to correct it is on your tax return itself.
The exact place you’ll make this adjustment on the tax return is on Schedule D and Form 8949. If you’re using tax prep software like TurboTax or FreeTaxUSA, you’ll just need to make sure that you reply “Yes” to the question, “Do you have adjustments to this investment sale?”
If you answer “Yes”, you can then select that the cost basis is missing or is incorrect, then provide the correct cost basis. The prep software will then adjust the Schedule D and Form 8949s to match what you’ve adjusted the cost bases to be.
You may have to manually go through your documents to determine what the cost basis of your RSUs is, but oftentimes companies will send a “Stock Plan Transactions Supplement” that has what the adjusted cost basis should look like.
Here’s what a supplemental report looks like (from Etrade) for reference:
The supplemental report can provide a little or a lot of data depending on how many sales of stock you had. Overall, this data can be really helpful for adjusting the cost bases of your shares relatively quickly. It’s also helpful because this same cost basis issue comes up with other types of shares (such as ESPPs) as well.
Example of Someone with RSU Double Tax
Continuing with the 1099-B example from earlier, there were two categories of RSUs that were sold that could have resulted in a double tax.
Short-term Non-covered
Long-term Non-covered
Here’s what was reported vs what it needed to be adjusted to:
As you can see, these particular RSUs were sold for a loss. This means that if an adjustment hadn't been made, there would have been both a double tax and we would not have been able to capture any capital losses!
Depending on the tax rate of the person in this example, making the adjustments to the cost basis would have saved them at least $1,000.
RSU Double Tax Conclusion
We hope you’ve found this information helpful and that you can avoid being taxed twice on your RSUs, because frankly, we see it happen all the time.
Companies are trying to make this process easier on employees, but it’s still far from simple. And every year, as tax time rolls around, both self-filers and tax accountants scramble to figure it all out.
EquityFTW has helped readers save tens of thousands of dollars by ensuring that the cost basis on their RSU sales is properly reported on their tax returns. If you’d like a little help with your situation, we’d be happy to connect you with professionals who can help.
Please feel free to reach out to team@equityftw.com if you have any questions about your RSUs or other equity compensation.