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Restricted stock units (RSUs): Overview, tax and pros & cons

Restricted Stock Units RSUs

What are restricted stock units?

Restricted stock units (RSUs) are a form of non-cash employee compensation offered by an employer without employees having to purchase them. The award of an RSU is the full value of the company stock instead of the appreciated portion only like options.

An RSU is one of the restricted stock variations. It’s called ‘’restricted’’ because oftentimes employees don’t earn the right to their RSUs until the restriction period has passed. This process is called vesting – a waiting period before earning the company stock.

How do RSUs work?

At grant:

You typically don’t have to pay anything and there is no real company stock issued. Instead, you’re promised to receive the company shares or the cash equivalent (depending on your plan rules) in the future once all RSU vesting requirements have been met.

RSU vesting:

When your RSUs vest, you’ll receive your shares and owe income tax.

Private companies that issue RSUs typically include a double-trigger vesting provision in the plan – two vesting triggers have to be satisfied before the grant is truly yours, e.g. a time-based requirement and IPO. With this mechanism, you only owe tax when the two events occur. By that time, you’ll likely be able to sell your RSUs to cover the tax bill. It resolves the problem that they have to pay taxes with their personal fund.

Selling your RSUs:

Once vesting is complete, you can sell your vested RSUs anytime or hold onto them. When you sell your stock, short-term/long-term capital gains will be taxed depending on the holding period.

How are RSUs taxed?

At grant:

An employee faces no tax bill at the grant date.

RSU vesting:

At the point of vesting, you’ll be liable for income tax on the full FMV of the stock subtracting the RSU cost basis. If there’s no purchase required, the cost basis of the RSU is zero.

Ordinary Income Tax on RSU at Vesting

  • FMV at vesting: $50/share
  • RSU cost basis: $0
  • Amount of RSUs vested: 250 shares (out of 1000)

Taxable income = 250 shares x ($50 – $0) = $12,500 (Subject to ordinary income tax – federal and state income tax, Social Security Tax and Medicare Tax).

Deductions could be processed through payroll with the employer withholding a portion of the RSU to pay any taxes. Assuming a 30% tax bracket, your tax bill in this example will be $3,750 (=12,500 x 30%), or 75 shares(=$3,750/50). After reducing the number of shares to cover your tax bill, the remaining shares will be deposited in your account – 175 shares (=250 – 75).

Selling your RSUs:

If you’ve held the stock for over a year after they vest, your profits will be long-term capital gains. The tax rates are typically lower than ordinary income tax rates.

Capital Gains Tax on RSU at Sale (2 years from vesting)

  • FMV at sale: $70/share
  • FMV at vesting: $50/share

Taxable profits = ($70 – $50) x 250 shares = $5,000 (Subject to long term capital gains tax)

It’s common to sell the vested RSUs immediately (before they increase or decrease in value) with a number of potential benefits. You can avoid CGT, pay the tax bill with the sale proceeds, diversify your financial portfolio and produce immediate cash to achieve other personal goals. Some, however, would decide to hold onto their RSUs after vesting. Remember: A restricted stock unit can fluctuate in value.

Summary of RSU tax treatment:

Grant
Vesting
Sale
No tax event
The entire amount of the vested stock is taxed as ordinary income in the year of RSU vesting
Any difference between the sale price and the FMV at the vesting date is taxed as capital gain or loss.
The amount is determined by subtracting the exercise price (which may be zero)
Short-term capital gain/loss: You’ve held the shares for one year or less before selling.
Long-term capital gain/loss: The holding period is at least one year.

RSUs at termination

Job termination oftentimes stops vesting. When it comes to RSUs at job termination, there are two situations: Vested vs unvested stock.

  • Vested RSUs: They are the shares you own. When you decide to leave, the vested RSUs will stay yours as you own company shares after vesting.
  • Unvested RSUs: They are the company shares that you have been promised but haven’t yet owned as vesting conditions haven’t been met yet. Quitting with unvested RSUs means you lose the right to receive company shares and the shares will return to the company immediately.

Depending on your plan and grant agreement, certain situations may allow vesting to continue or even accelerate, e.g., death, disability, or retirement.

Benefits of RSUs

  • Long-term motivation: Commonly used as a long-term incentive, employee are incentivized to work harder in a long run in order to receive greater awards over time.
  • No exercise price: Unlike stock options, there’s typically no purchase necessary for an RSU. As soon as they vest, they’ll be transferred to you. By that time, you’ll own them and be able to sell them anytime. Read more about RSU vs options.
  • Less risk. An RSU is a full-value award based on the company value. As long as the company stock price doesn’t drop to $0, it will always be worth something.
  • Delay dilution: RSUs allow a company to defer issuing shares until the vesting is complete.
  • Simple RSU taxation: Taxes are simpler than stock options.

Drawbacks of RSUs

  • Not able to earn unvested RSUs: If you leave the company or are fired before your RSUs are fully vested, then those shares go back to the company
  • Not able to time taxes: RSUs are taxed as they vest – the employee has no ability to time their taxes as they would with options. If you owned a double-trigger RSU, your vesting period would be uncertain. You could face a hefty tax burden once a liquidity event occurs.
  • Not eligible for the IRC 83(b) Election: This election is available for restricted stock awards (RSAs) – another type of restricted stock. An 83b allows an employee to pay tax before vesting, which the taxable amount before vesting is usually smaller (can be $0) than that upon vesting. So, with an 83b election, employees can get benefits from a small tax bill but the election is not available for an RSU. Read more about RSU vs RSA

FAQs about Restricted Stock Units:

What is an RSU?

An RSU is a form of employee compensation offered by an employer as a form of company shares. Typically, there’s no purchase necessary. At the time of the grant, there’s no actual company shares issued. Employees will receive the shares once the vesting period is complete. This motivates employees to stick around and work harder to grow the company’s value.

How is an RSU taxed?

RSU taxation is simpler than stock option’s. RSUs generally are not taxable at grant. Upon vesting, the entire amount of the vested stock (subtracting exercise price) is taxed as ordinary income. When you sell your RSUs, the difference between the sale price and the FMV at the vesting date is taxed as capital gain or loss.

Does 1 RSU equal 1 stock?

One RSU corresponds to one share of company stock.

Should I sell RSU right away?

Ultimately, it depends on your specific situation. It’s common to sell the vested RSUs immediately before they increase or decrease in value. By doing so, you can pay the tax bill at vesting with the sale proceeds, avoid any CGT, diversify your financial portfolio and produce immediate cash to achieve other personal goals.
Some, however, would decide to hold onto their RSUs after vesting. Remember: A restricted stock unit can increase or decrease in value. We would suggest consulting with an advisor who can help you determine which option is appropriate for you.

How do RSUs work at a private company?

If your RSUs vest when your company is still private, you won’t likely be able to sell your shares to cover the taxes upon vesting. So, you’ll need to pay the tax out of pocket.

Thankfully, there is a type of RSU called ‘’Double-Trigger RSU’’ – You’ll need to meet two vesting conditions before the shares are truly yours – for example, a time-based one and IPO.

So in this case, the employees holding RSUs in private companies only owe tax when the two events occur. By that time, they’ll likely be able to sell their shares to cover the tax bill rather than using their personal fund.

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Please Note: This publication contains general information only and Global Shares is not, through this article, issuing any advice, be it legal, financial, tax-related, business-related, professional or other. The Global Shares Academy is not a substitute for professional advice and should not be used as such. Global Shares does not assume any liability for reliance on the information provided herein.

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