If you work for a company that offers Restricted Stock Units (RSUs) to its employees or are considering employment with a company that includes RSUs in their compensation package, it’s important to understand how RSU stock works.
RSUs are a popular form of equity compensation that can be complex and requires thoughtful planning. Join our Raleigh CPAs as answer common questions like “What is a Restricted Stock Unit”, explore how RSUs work, their tax implications, and their advantages and disadvantages, providing you with valuable insights to navigate this form of compensation.
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What is a Restricted Stock Unit and What Does RSU Stand For?
RSU stands for Restricted Stock Unit. Now, what is a restricted stock unit? It is a form of equity compensation granted by an employer to an employee. RSUs represent a promise to deliver company shares or their cash equivalent to the employee at a future date, typically after meeting specific vesting conditions or performance milestones. RSUs are similar to stock options but do not require the employee to purchase the stock, but they are subject to certain restrictions until they vest.
RSUs are particularly common in technology companies, where they can account for a significant portion of an employee’s annual compensation, often exceeding 50% of the total pay.
Understanding Equity Awards as Employee Compensation
What is a restricted stock unit in regard to employee compensation? Equity awards are a form of compensation that offer employees ownership in their company. They align employee interests with the company’s success and often come in various forms, including stock options, RSUs, and performance shares.
Types of Equity Awards
Stock Options
Gives employees the right to buy shares at a set price. If the stock price rises, they profit.
Restricted Stock Units (RSUs)
Shares granted over time, becoming yours once vested. Taxes are due when they vest.
Performance Shares
Shares that vest only if company performance goals are met.
Why Companies Offer Equity Awards
Attract Talent and Retain Employees
Equity awards are used to attract new talent and maintain employee retention.
Incentivize Success
Aligns employees’ financial interests with company performance.
Long-Term Focus
Employees benefit from the company’s growth, motivating them to stay and contribute.
What is RSU in Salary?
RSUs are a form of equity compensation offered by employers as part of your salary package. They are company shares granted to you, but they come with conditions that must be met before you can fully own them.
Part of Total Compensation
RSUs are often offered in addition to your regular salary, bonuses, or benefits as a way for companies to reward employees and incentivize long-term commitment.
Vesting
RSUs are subject to a vesting schedule, meaning you must stay with the company or meet performance goals for a certain period before you receive full ownership of the shares.
Taxable as Income
When the RSUs vest, their value is considered taxable income and is subject to regular income tax.
In essence, RSUs are a way to provide employees with company stock over time, aligning their interests with the company’s success.
How Do Restricted Stock Units Work?
Now that you know what is a restricted stock unit, let’s explore how they work. RSUs are a form of compensation where your company grants you shares of stock, but the shares are “restricted” until certain conditions are met. These conditions for restricted stock awards often involve staying with the company for a specific period or meeting certain performance goals. Once these conditions are met, the RSUs “vest,” and you gain full ownership of the shares.
RSU Grant Date
The grant date is when your company officially grants you the RSUs. This is the moment when the company promises to award you a specific number of shares in the future. However, these shares are “restricted” and cannot be sold or transferred until certain conditions (like time or performance-based goals) are met.
What it means for you: The grant date doesn’t require any action from you. It’s simply when your company informs you of the RSUs you’re entitled to. However, these shares aren’t yours yet—you must wait for them to vest.
RSU Vesting Schedule
The vesting schedule determines when you’ll actually receive the RSUs as your own. Vesting means that the restrictions on the shares are lifted, and you gain full ownership of them.
A vesting period might be based on time or performance standards:
Time-Based Vesting
This is the most common type of vesting. You may receive a percentage of your RSUs after a certain period, such as one year or every year thereafter, for several years.
Performance-Based Vesting
In this case, your RSUs vest based on meeting specific company performance targets, like achieving a certain revenue goal or completing a successful product launch.
What it means for you: You can’t sell or transfer your RSUs until they vest. If you leave the company before your RSUs vest, you may forfeit them.
RSU Vesting Date
The vesting date is when your RSUs are no longer “restricted” and officially become yours. This is the day that you legally own the shares and can sell them if you choose, or hold onto them as an investment.
What it means for you: On the vesting date, the fair market value of the RSUs becomes real to you. If the company’s stock price has risen, the value of your vested shares may have increased as well. If the stock unit price has decreased, the value of your shares will be lower, but they are still yours once vested.
Taxes and RSUs
The income tax liability of RSUs are relevant when they vest. The market price of the shares at the time of vesting is treated as ordinary taxable income. Your employer may withhold taxes, meaning they may sell a portion of the vested shares to cover the liability for federal income tax purposes.
What it means for you: When the RSUs vest, the value of the actual shares is included in your income for that year. For example, if your 1,000 RSUs vest and are worth $50 per share, you’ll owe taxes on $50,000. Taxes may be withheld by the company, or you may need to pay them when filing your tax return.
If you choose to sell the shares after they vest, any increase in value after the vesting date may be subject to capital gains tax. Holding shares for more than a year after vesting could qualify you for long-term capital gains tax rates, which are often lower than short-term rates.
Selling or Holding Vested Shares
Once your RSUs vest, you have options regarding what to do with the shares. You can sell them immediately to cash out, or you can hold onto them in hopes that the stock price will rise to a higher market price.
What it means for you: After vesting, the shares are yours to do with as you please. If you sell the shares immediately, you’ll likely owe ordinary income taxes based on their market value at vesting. If you hold onto the Restricted Stock Unit shares, you could benefit from any future growth in the company’s stock price, but also take on the risk if the stock price declines.
What Are RSU Grants’ Tax Implications?
RSUs are a great way to earn company stock, but they come with important tax considerations.
Taxation at Vesting
When RSUs vest, the value of the shares is considered ordinary gross income, and you are taxed on that amount. Your employer will typically withhold tax owed, often by retaining a portion of the shares to cover the tax bill.
Capital Gains Tax on Sale of Shares
After RSUs vest, if you sell the shares, any increase in value is taxed as capital gains. If you sell the shares within a year, you pay short-term capital gains tax, but if you hold for over a year, you qualify for long-term capital gains tax, which is usually lower.
Example of RSU Taxation
If 250 RSUs vest at $50 per share, you’ll pay taxes on $12,500 as ordinary income. If you sell them later at $60 per share, you’ll owe capital gains tax on the $10 per share profit, depending on how long you hold the shares.
Tax Strategies and Planning
To manage the tax impact of Restricted Tax Units, you could sell your shares immediately after vesting to cover taxes, or hold them longer to benefit from lower long-term capital gains tax. Consulting a local tax consultant can help with strategic planning.
Advantages of RSUs
RSUs offer several benefits that make them an attractive option for both employers and employees. These advantages can make RSUs a straightforward and reliable form of compensation. Below are the key benefits of RSUs and why they might be a valuable addition to your compensation package.
Simplicity
RSUs are easy to understand compared to other equity compensation options like stock options. The vesting schedule and share value are clear, so you know exactly when and how much you will receive.
No Purchase Necessary
With RSUs, you don’t need to buy the shares to receive them. They are granted to you at no cost, and you only pay taxes when the shares vest and become your property.
Retention of Value
Unlike stock options, which can become worthless if the stock price falls below the strike price, RSUs retain value unless the company’s stock price drops to zero. Even if the price falls, the shares still have value, providing some security.
Flexibility
Once RSUs vest, they are yours to sell or keep as you see fit. You can use them for various financial goals, such as contributing to retirement accounts, paying off debt, or funding other personal priorities.
Disadvantages of RSUs
While RSUs have several advantages, they also come with their own set of challenges. It’s important to understand these drawbacks to make informed decisions about how to manage RSUs within your compensation package.
Tax Consequences
RSUs are taxed as ordinary income when they vest, which can result in a large tax bill. If the company is not public or if you can’t sell shares to cover the taxes, you might face challenges paying the required amount.
No Dividends Before Vesting
RSUs do not pay dividends until they are fully vested. This means you miss out on any dividend income from the shares during the vesting period, unlike shareholders who receive dividends on their stock.
Vesting Requirements
If you leave the company before your RSUs vest, you forfeit those shares. This can be a disadvantage if you’re close to the vesting date but decide to move on from the company.
Stock Price Decreases
The value of RSUs is tied to the company’s stock price, and if the price decreases between the grant and vesting dates, the value of your RSUs will decrease as well, potentially reducing the financial benefit you were expecting.
Contact Our Restricted Stock Unit Tax Professionals in Raleigh
If you’ve recently vested in RSUs or are planning to, you may have questions about how to manage your tax obligations. At Steward Ingram & Cooper, our tax advisors help clients navigate the complexities of RSUs and maximize their financial benefits. Our Raleigh tax professionals can help you understand your tax situation and explore strategies for minimizing the impact.
For RSUs and tax planning guidance, contact our team of CPAs today at (919) 872-0866 or fill out the contact form below to get started.