The RSU cost-basis trap on Form 1099-B: how people pay tax twice without noticing

What happens when RSUs vest

A restricted stock unit is a promise to deliver shares if you are still there on a future date. Until that date, nothing has been transferred to you and nothing is taxable.

On the vesting date, the shares are delivered and the fair market value of those shares becomes ordinary compensation income. It runs through payroll. It appears in your Form W-2 wages, and Social Security and Medicare tax apply to it. This is the same treatment as a cash bonus paid in stock.

Two consequences follow, and the second is the one people lose track of.

First, the value at vest has already been taxed as ordinary income. Second — and this is the part that matters in April — that same amount is your cost basis in the shares. You are treated as having bought them for what you were taxed on.

Why the 1099-B is missing the basis

Sell the shares, and your broker issues Form 1099-B. Box 1e is cost basis. For RSU shares, that box is frequently zero, or blank, or filled with a figure that ignores what you already paid tax on.

This is not a broker error. Treasury Regulation section 1.6045-1(d)(6)(ii)(A) provides that a broker may not increase initial basis for income recognized upon the exercise of a compensatory option, or the vesting or exercise of other equity-based compensation arrangements, granted or acquired on or after January 1, 2014. The regulation prohibits the broker from including it.

The logic, from the IRS side, is that the broker does not reliably know what went on your W-2. The consequence, from your side, is that the form arrives understating your basis by exactly the amount you were already taxed on.

What double taxation looks like

Say 100 shares vest at $50. That is $5,000 of compensation income on your W-2, taxed at ordinary rates. Your basis in the 100 shares is $5,000.

You sell the next week at $51. The real gain is $100.

The 1099-B reports proceeds of $5,100 and basis of $0. Type that into tax software as printed and you have reported a $5,100 capital gain. You have now paid tax twice on $5,000 — once as wages, once as gain.

Scale that to a few vesting tranches at a company with a rising share price and the overstatement runs into five figures.

The correction

The mechanism is Form 8949, and the IRS prescribes exactly how to use it.

Report the transaction with the basis as the broker reported it in column (e). Enter code B in column (f). Enter the amount of the correction in column (g), as a negative adjustment to gain. Column (h) then carries the correct gain or loss forward to Schedule D.

Code B is defined in the Form 8949 instructions as the code to use when you received a Form 1099-B and the basis shown in box 1e is incorrect. That is precisely this situation.

Where do you get the right number? Most brokers issue a supplemental information statement alongside the 1099-B showing the adjusted basis. It is not an IRS form and there is no mandated format, but virtually every major brokerage provides one. If yours does not, the figure is the fair market value per share at vest multiplied by the number of shares delivered, which your equity administration platform will show.

Holding period

The holding period for the shares starts at vest, not at grant. Sell within a year of vesting and any gain above basis is short-term, taxed at ordinary rates. Sell more than a year after vesting and it is long-term.

Because the shares are almost always sold shortly after vest, the typical outcome is a small short-term gain or loss. That is a normal result, not a sign something went wrong. What is not normal is a gain equal to the entire value of the shares.

Withholding, and why it is usually short

Employers withhold on RSU income at supplemental wage rates. For federal purposes, the flat rate on supplemental wages is 22 percent, rising to 37 percent on supplemental wages exceeding $1 million during the year.

If your marginal federal rate is 32 or 35 percent, a flat 22 percent withholding leaves a gap. Most people notice it for the first time in April.

California adds its own layer. The Employment Development Department’s DE 44 sets the state supplemental withholding rate at 6.6 percent generally, and 10.23 percent for bonuses and stock options. California prescribes the 10.23 percent rate for bonuses and stock options, which is the rate that generally applies to equity compensation. Either way, the same gap logic applies: California’s top marginal rates run well above both figures.

The remedy is not complicated. Increase withholding on your regular wages, or make an estimated payment in the quarter the vest occurred. Our piece on quarterly estimated taxes in California covers the safe harbors that keep the shortfall from becoming a penalty.

California specifics

No preferential capital gains rate. The Franchise Tax Board is direct about this: California does not have a lower rate for capital gains, and all capital gains are taxed as ordinary income. The federal long-term versus short-term distinction has no California equivalent. Holding for a year saves federal tax and saves nothing at the state level.

Moving in or out of the state. If you worked in California during part of the period between grant and vest and lived elsewhere for the rest, only the California-source portion is taxable to California. FTB Publication 1004 sets out a workday-allocation approach for restricted stock: the ratio of California workdays between grant and vest to total workdays over the same period. The same methodology is applied by analogy to restricted stock units. This is where people leaving California most often get it wrong, in both directions — some report everything to California when they should not, and some report nothing when a portion was earned here.

If you already filed it wrong

This is fixable, and the money is usually worth recovering.

Federally, the deadline to claim a refund is generally the later of three years from the date you filed the return or two years from the date you paid the tax. You would file Form 1040-X with a corrected Form 8949 and Schedule D.

California’s window is a three-part test, and the deadline is the latest of: one year from the date of the overpayment, four years after the original due date of the return, or four years after the date a timely return was filed within the extension period. The state form is Schedule X, filed with an amended Form 540.

The practical point is that a mistake made three years ago is very often still recoverable.

How to check your own return

Pull last year’s Form 8949. Find the rows for shares sold shortly after an RSU vest. If column (e) shows zero or a figure noticeably below the market value at vest, and column (f) is blank, the adjustment was not made.

Then compare the total gain reported on Schedule D against what you know actually happened. If shares vested and were sold within days at roughly the same price, the gain should be small. A large gain in that fact pattern is the signature of this error.

Common questions

Why does my Form 1099-B show zero cost basis for RSU shares?

Treasury Regulation section 1.6045-1(d)(6)(ii)(A) prohibits a broker from increasing the reported basis by income recognized on the vesting of an equity-based compensation arrangement granted or acquired on or after January 1, 2014. The broker is required to exclude the amount already taxed on your W-2.

How do I correct the cost basis for RSUs on my tax return?

On Form 8949, report the basis as the broker reported it in column (e), enter adjustment code B in column (f), and enter the correction in column (g). Code B is the code for a Form 1099-B showing an incorrect basis in box 1e.

What is my cost basis in RSU shares?

The fair market value of the shares on the vesting date, which is the same amount included as compensation in your Form W-2 wages.

Can I make a section 83(b) election on restricted stock units?

No. IRS Publication 5992 states that restricted stock units are not considered property for purposes of Internal Revenue Code section 83, because no actual property has been transferred. The election is not available for RSUs.

Does California tax RSU gains at a lower capital gains rate?

No. The Franchise Tax Board states that California does not have a lower rate for capital gains and that all capital gains are taxed as ordinary income.

Can I still fix a prior year return where I paid tax twice?

Often, yes. The federal refund window is generally the later of three years from filing or two years from payment. California's window is the latest of one year from the overpayment, four years after the original due date, or four years after a timely return filed within the extension period.