Don't Pay Taxes on Your RSUs Twice: A Common Tax Season Pitfall
As we find ourselves in the midst of another tax season, let's address a common mistake I come across year after year: double taxation on Restricted Stock Units (RSUs). If you're one of the many professionals who receive RSUs as part of your compensation package, you might be unknowingly paying taxes twice on the same income when you sell those shares.
It's remarkably easy to make this mistake. Your RSU income typically appears on your W-2, but it often doesn't have a separate line item telling you exactly how much of that W-2 income came from RSUs. When you later sell those shares, the connection between your previously taxed income and the stock sale isn't automatically made, leading to potential double taxation.
To avoid this costly error, it's crucial to gather the following information before preparing your taxes:
Which specific shares you sold from which grant
Which shares vested from which grant
The exact vesting date of each share
The sale date of each share
The fair market value of the shares on the vesting date
Your Stock Plan accounts supplemental forms
Armed with this information, you can properly account for your RSU sales and avoid paying taxes twice on the same income. This costly error affects countless taxpayers each year, but with proper understanding, you can avoid it and potentially recover taxes you've overpaid in previous years.
RSUs are taxed at two distinct points in your investment journey. First, when your RSUs vest, the shares' market value becomes taxable as ordinary income. This income appears on your pay stub and is reported on your W-2. Your employer typically withholds taxes by selling a portion of shares to cover the tax obligation. Later, when you sell the shares, you're taxed only on the difference between the sale price and your cost basis (the value of the shares at vesting). This is where things often go wrong. The issue stems from the fact that RSUs are considered "non-covered securities" by custodians, meaning they aren't required to report the cost basis on Form 1099-B. This key detail is often overlooked by both tax preparers and individuals filing their own returns.
Case Study
Michael works at a tech company and received 500 RSUs that vested when the company's stock price was $200 per share, resulting in $100,000 of ordinary income. This $100,000 was properly reported on his W-2 and taxed as regular income. A few months later, Michael sold all 500 shares for $240 per share, receiving $120,000.
Michael's true capital gain is only $20,000 ($120,000 sale proceeds minus his $100,000 cost basis). He should pay capital gains tax only on this $20,000.
However, Michael's 1099-B from his brokerage showed his sale proceeds of $120,000 but listed his cost basis as $0 in Box 1e. If his tax preparer transfers this information directly to his tax return without making any adjustments, the entire $120,000 would be treated as a capital gain, even though $100,000 had already been taxed as ordinary income on his W-2.
Let's calculate the financial impact:
If Michael is in the 37% marginal tax bracket and the sale was a short-term capital gain (also taxed at 37%), the double taxation would cost him an additional $37,000 ($100,000 × 37%) in unnecessary taxes. That's tens of thousands of dollars that should rightfully stay in Michael's pocket.
Here’s what should have happened on Michael’s tax return:
If Box 1e on Form 1099-B has no cost basis (as is common with RSUs):
Report the $120,000 in proceeds as shown on his 1099-B on Form 8949
List the correct cost basis ($100,000) directly in column (e) on Form 8949
Check Box B (or E for long-term gains) at the top of Form 8949
No adjustment or code is needed in columns (f) or (g)
This would ensure Michael only pays capital gains tax on the actual gain of $20,000, avoiding double taxation on the $100,000 that was already reported as income on his W-2.
How to Check Your Situation
To check if you've made this mistake in previous years, review your past three years of tax returns, specifically Form 8949 (Sales and Other Dispositions of Capital Assets). Compare the cost basis shown on your tax return with the information from your broker's supplemental information. If the numbers don't match, you likely have an error on your return that caused you to pay more tax than necessary. If you discover you've paid double tax in previous years, you can amend returns that are within the three-year statute of limitations by filing Form 1040-X, Amended U.S. Individual Income Tax Return.Consider attaching documentation that shows the correct cost basis to make it easier for the IRS to process your amendment. Be aware that the IRS may take 6-12 months to process amended returns.
Understanding the taxation of RSUs is crucial to avoiding double taxation. When you sell RSUs, remember that your cost basis is the value of the shares when they vested, which has already been taxed as ordinary income. Don't rely solely on the 1099-B form from your broker. Instead, look for supplemental information that shows the correct cost basis, and make the proper adjustments on your tax return.
If you believe you may have fallen victim to this error in past tax returns, there's still hope. You can file an amended return (Form 1040-X) with a corrected Form 8949 following the steps outlined in this article. The IRS allows you to amend returns filed within the last three years, potentially recovering thousands in overpaid taxes. For someone in Michael's situation in the 37% tax bracket, that could mean recovering $37,000 for just one year's mistake and potentially more if the error occurred across multiple years.
The Bottom Line: Get Professional Guidance
If you feel like you could benefit from a second set of eyes on your tax situation, especially if you have RSUs or other equity compensation, feel free to reach out to me. I’ve helped many professionals simplify their equity and tax situations.
Need a second set of eyes on your tax situation? Book an Intro to get started.
This article is for informational purposes only and does not constitute tax advice. Please consult with a qualified tax professional for advice specific to your situation.
