If you work for a company that offers Restricted Stock Units (RSUs) to its employees or are considering employment with a company that offers RSUs as a benefit, you probably want to know as much as you can about them. Restricted stock units are a common addition to your compensation package; however, they can be complex and require detailed planning for you to get the greatest reward.
At Steward Ingram & Cooper, we have experience working with clients who have RSUs. We hear a lot of questions such as how these units are taxed and when they are taxed. In this article, we cover these questions and more so that you can learn everything you need to know about RSUs.
What are Restricted Stock Units?
Restricted stock units are a type of equity compensation that grants employees a specific number of company shares subject to a vesting schedule and potentially other stipulations. An RSU is a promise from your employer to give you shares of the company’s stock or the cash equivalent on a future date. You can think of RSUs as a cash bonus that can go up or down in value. RSUs are similar in concept to traditional stocks, but their payoff and vesting period make them quite different.
Restricted stock units are popular as a type of compensation for companies in the Technology industry. Compensation from RSUs can be over 50% of the total annual pay at some technology companies.
The recipient (the employee–you) must meet certain conditions before the RSUs are transferred to the owner. Typically, RSUs are issued to employees via a vesting plan and distribution schedule. In other words, there have been restrictions placed on the award, and the process of meeting the conditions is called “vesting.” RSUs can be issued at the time of employment and are distributed after you achieve stated performance milestones or after remaining with the employer for a specific length of time.
The two key dates for RSUs are:
- Grant date. The grant date is the date that your company promises a specific number of “restricted” shares to you, the employee. These shares are earned over a vesting period.
- Vesting date. The vesting date is the date on which the shares are no longer “restricted” and become owned by you.
How RSUs Work
RSUs don’t require an employee to pay for anything to get the stock. You are only responsible for paying the applicable taxes when you receive the shares. Restricted stock units give employees interest in the employer’s equity but have no tangible value until they are vested. Upon vesting, the RSUs are assigned a fair market value (FMV). Once the units are vested, the restricted stock units are considered income and a portion of the shares is withheld to pay income taxes. At that time, the employee receives the remaining shares and has the right to sell them.
Here is an example of how RSUs work in practice:
- Jim was granted 4,000 RSU shares in April 2021.
- 25% of Jim’s RSUs (1,000 shares) vest in April of 2022 with equal vesting over four years.
- On the vesting date, the share price is $50. This is Jim’s cost basis if he holds the shares.
- Jim owes taxes on $50,000 ($50 X 1,000 shares) of RSU income for 2022.
- If Jim is in the 35% Federal tax bracket, his total tax bill on the shares is $17,500 (35% X $50,000).
Types of Restricted Stock Units
Employers can offer RSUs with different restrictions. Some are subject to only a vesting schedule and are referred to as single-trigger RSUs. Others may include additional conditions that must be met along with vesting called double-trigger RSUs.
Single-Trigger RSUs–Time-Based Vesting
A time-based vesting schedule that is established for RSUs can vary. For example, you may get a certain percentage of your RSUs after a certain length of time with installments at specific intervals later.
Here is an example of this type of vesting schedule:
Let’s say that you have been granted 1,500 RSUs and the vesting schedule is 20% after one year of service and then equal quarterly installments thereafter for the next three years. This would mean that you receive 300 shares after you have stayed with the company for a year. You now own 300 shares. For the next three years, every quarter that you remain employed by the company, you would receive ownership of another 100 shares.
This is a graded vesting schedule with periodic grants vesting over a few years. Employers can also use cliff vesting, where all grants vest together at once. For instance, this would be the entire 1,500 shares vesting after three years.
Double-Trigger RSUs–Performance-Based Goals
Restricted Stock Units can have other restrictions beyond a vesting schedule, primarily based on performance. Perhaps the company needs to reach certain milestones such as a product or service launch or go through events like a merger, acquisition, or becoming a public company through an initial public offering, direct listing, or SPAC listing. Once this event occurs, the employee receives the RSUs.
Tax Liability of RSUs
For tax purposes, restricted stock units are treated differently than other forms of stock options. RSU compensation is taxed as ordinary income in the year of vesting. The value is based on the shares’ value on the vesting date.
To declare the amount, an employee must subtract the original purchase of the stock or its exercise price from the Fair Market Value (FMV) on the date it becomes fully vested. The difference is declared as ordinary income by the taxpayer (recipient). However, if you hold the shares for a year or longer after vesting, any gain or loss is taxed as long-term capital gains. If you hold the shares for less than one year after vesting, gains are taxed at short-term capital gains tax rates.
Using our earlier example of Jim’s restricted stock units, let’s look at both a long-term and short-term capital gain situation:
- On the vesting date, the share price is $50. This is Jim’s cost basis.
- If Jim holds the shares for longer than a year, and sells them when the FMV is $60 per share, he will pay long-term capital gains tax on $10 per share (the difference between $50 per share, which is his cost basis, and $60 FMV). For 1,000 shares, this is $10,000 on which he will pay long-term capital gains tax.
- If Jim holds the shares for 6 months (less than a year), and sells them when the FMV is $60 per share, he will pay short-term capital gains tax on $10 per share (the difference between $50 per share, which is his cost basis, and $60 FMV). For 1,000 shares, this is $10,000 on which he will pay short-term capital gains tax.
Some companies may offer you the ability to offset your tax liability by reducing the shares received by the amount of tax owed. For example, if you have 300 shares vest and they are worth $10 a share, you will need to pay tax on income of $3,000. Assuming you are in a 30% tax bracket, your tax bill will be $900, or 90 shares. You may be able to elect to receive only 210 shares, using 90 shares to cover your tax bill. Not all companies offer this perk, which leaves you to pay the entire tax upon vesting. For information on tax breaks, click here.
Why Companies Issue RSUs
Companies use RSUs as an incentive to attract and retain talent. RSUs are appealing to employees because if the company performs well and the share price increases, they can receive a significant financial benefit. This can motivate employees to take ownership and stay for the long term, thereby improving retention.
Advantages and Disadvantages of Restricted Stock Units
There are both advantages and disadvantages to restricted stock units.
Advantages of RSUs
- Simplicity–Compared to other forms of equity compensation such as employee stock options, RSUs are easier to understand. The vesting schedule is specified clearly as to when you will receive shares and the calculation of the value is clear-cut.
- No purchase is necessary–With RSUs the shares become yours upon vesting and there is no purchase required. As compared to stock options, you have the right to purchase shares of company stock at a certain price.
- Retention of value–RSUs will have value (unless the value of your company’s share price goes to $0); stock options may not have value. With stock options, there are various factors that you must consider such as the strike price when you exercise your options. With RSUs, if 300 shares vest at $10 a share, selling yields $3,000. Even if the share price drops to $5 a share, you could still make $1,500.
- Flexibility–Once shares vest, they are yours even if you leave the company. RSUs provide employees with flexibility, particularly if the company is publicly traded. Employees can sell vested shares to fund other priorities such as funding retirement accounts, paying off debt, funding a down payment on a house, or contributing to a child’s college savings account.
Disadvantages of RSUs
- Tax consequences–If your company isn’t public and is unable to assist with offsetting your tax burden, it may be difficult to find the cash to afford the taxes. A tax professional can help you look at tax strategies that could potentially lessen the tax burden.
- RSUs don’t provide dividends before they vest.
- Vesting–The shares aren’t yours until the vesting criteria are met. In other words, if you leave your employer before vesting, you forfeit the income.
- Stock price decreases–Compared to a cash bonus if the value of your company’s stock decreases between the grant and vesting date, your RSU income decreases.
Contact Our Restricted Stock Unit Tax Professionals in Raleigh
If you have vested in restricted stock units at your employer this tax year, you may have questions about the tax consequences and how selling your shares can affect your tax situation. Our tax professionals have the experience to help you understand the specifics of taxation for your RSUs and look for potential tax strategies that can help. Our dedicated team at Steward Ingram & Cooper, PLLC is ready to assist you in any way we can. Call us at (919) 872-0866 or complete the contact form below.