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RESTRICTED STOCK

RSUs are a key form of equity compensation. Learn how they function, how they’re taxed, and how to optimize investment returns.

  • RSUs are a common form of taxable equity compensation.
  • After vesting, shares sold as capital gains.
  • RSU taxes can help you save money and boost investment returns.
  • Managing RSUs reduces concentrate, income, and career risk.
  • When buying/selling company stock, executives and insiders must follow SEC requirements.

A restricted stock unit (RSU) is an unfunded employer promise to transfer stock at a future date. Most RSU plans require employees to meet vesting requirements before receiving equity. Since RSU stock is vested at transfer, it is subject to IRC Sec. 409A [Reg. 1.409A-1(b)(66)] (ii). RSU schemes that offer shares that will be transferred within 2 1/2 months are not subject to IRC Sec. 409A.

An election under IRC Sec. 83(i) allows a qualified employee to defer income from an RSU or option of nonpublicly-traded stock for up to five years.

RSUs are taxed when vested and the stock is delivered, not when sold. When vested, the employee buys company shares at FMV and the value is taxable income. The employer withholds taxes on vested RSUs by taking a percentage of newly delivered shares and giving the rest to the employee. When an employee sells issued shares, they are considered short-term and long-term capital assets.

Tax Planning Tip: When a large block of RSUs vests, the taxpayer may be able to accelerate state income tax and property tax deductions (up to the $10,000 annual maximum) that would not be eligible if the taxpayer was subject to AMT.

Employers can grant restricted stock and RSU dividends and DEUs. DEUs can be paid with stock dividends or after vesting. DEUs are a different benefit from RSUs and have the same conditions (Rev. Rul. 2012-19). DEUs are treated as ordinary income if performance-based vesting is not required (CCA 201414018).

What are RSUs?

RSUs are a key form of equity compensation. Learn how they function, how they’re taxed, and how to optimize investment returns.

  • RSUs are a common form of taxable equity compensation.
  • After vesting, shares sold as capital gains.
  • RSU taxes can help you save money and boost investment returns.
  • Managing RSUs reduces concentrate, income, and career risk.
  • When buying/selling company stock, executives and insiders must follow SEC requirements.

RSUs are a type of compensation that is linked to the value of your employer’s stock price. Consider RSUs to be a cash bonus that can fluctuate in value.

RSUs are “restricted stock units,” as the name implies. In other words, you won’t be able to sell them until you meet the vesting criteria, which is usually a set number of months or years.

The following are the two key dates for RSUs:

The grant date.  When a company promises employees “restricted” shares of stock.

The vesting date. When the shares are no longer “restricted” and become the employee’s property.

RSUs are taxed as income when they vest. Shares typically vest in tranches over time—four years is typical.

Restricted Stock Units (RSUs) are a popular form of compensation for those working in the technology industry. In some cases (for example, Amazon employees), RSU compensation can account for more than half of total annual pay. As a Tech employee, it is essential to have a thorough understanding of RSUs.

How Do RSUs Work?

Unlike other types of equity compensation, RSUs are simple once a few key terms are defined.

Grant Date: On this date, your employer grants you “restricted” shares. These shares are obtained over a vesting term, which could be months or years or related to performance goals. These shares are obtained over a vesting term, which could be months or years or related to performance goals.

Vest Date: The date on which the shares officially become yours (i.e., they are no longer “restricted”). A typical vesting schedule calls for 25% of the shares to vest each year for four years.

RSU Taxes: RSU compensation is taxed as ordinary income when the shares vest and is calculated based on the value of your shares on the vesting date. Consider them a cash bonus tied to the price of your company’s stock. If you keep the shares for a year or more after they vest, any profit (or loss) is taxed as long-term capital gains (shares held less than one year from vesting are taxed at short-term capital gains tax rates).

Types of RSUs

RSUs are classified into two types: single-trigger and double-trigger.

Single-trigger RSUs have only one vesting condition (typically time-based) and are common in publicly traded companies.

Double Trigger RSUs are common in private companies and have a second set of criteria (typically related to a liquidity event for the company). A time-based vesting schedule in conjunction with your company’s IPO or acquisition is a common double vesting RSU practice. In this case, the RSUs are worthless unless the company goes public, and if you leave your job, you can’t keep the shares because they haven’t fully vested.

Types of RSU Vesting Schedules

RSU vesting schedules are also classified into two types:(Graded)

Vesting Schedule:  RSUs vest in this manner on a regular basis over a period of years. They could vest equally or on a different schedule (for example, 40% in year one and then 20% in each of the next three years).

“Cliff” Vesting Schedule:  With a “Cliff” vesting schedule, all of your RSUs vest at the same time. This “Cliff” could be initiated after a specific period of service or connected to company or individual performance achievement.

Vesting usually stops when you leave your job. However, as part of severance or retirement packages, some employers will offer a year (or more) of vesting acceleration (or potentially in the case of death or disability).

The Benefits and Drawbacks of RSUs

RSUs, a popular form of equity compensation, have a number of advantages but also some disadvantages.

RSU Advantages

RSUs work and are taxed in a straightforward manner when compared to other forms of equity compensation.

Advantage: Unlike a cash bonus, RSUs allow you to participate in your employer’s success through an increasing stock price.

Retains Value: Unlike stock options, which have a fixed strike price, RSUs are always worth something when they vest (unless your company’s stock price falls to zero).

RSU Disadvantages

Vesting: You do not own the shares until the vesting criteria are met (i.e., if you leave your employer, you forfeit this income)

Illiquidity: In the case of a private company, shares cannot be transferred or sold until the company experiences a liquidity event.

Downside: Unlike a cash bonus, your RSU income decreases if the value of your company’s stock falls between the grant and vesting dates.

RSUs Taxation
  • RSUs are taxed differently than options and ESOPs (ESPP).
  • RSU taxation is simple compared to other equity payments.
  • RSUs are taxed differently than options and ESOPs (ESPP).
  • RSU taxation is uncomplicated compared to other forms of equity compensation, but it has a few distinctive characteristics.
  • When RSUs vest, they’re taxed as income.
  • If you sell your shares immediately, you simply pay income taxes.
  • Any gain (or loss) from holding shares past the vesting date is taxed as a capital gain (or loss).
  • RSUs are taxed like a cash bonus used to buy company stock on the vesting date. Consider RSUs a monetary bonus to master RSU taxation. , only with a few distinctive traits.

How RSUs are Taxed:

  • When RSUs vest, they’re taxed as income.
  • If you sell your shares immediately, you simply pay income taxes.
  • Any gain (or loss) from holding shares past the vesting date is taxed as a capital gain (or loss).
  • RSUs are taxed like a cash bonus used to buy company stock on the vesting date. Consider RSUs a monetary bonus to master RSU taxation.

Key Dates for RSU Tax Treatment

RSU tax at vesting date is:

The # of shares vesting x price of shares = Income taxed in the current year

When RSU shares are sold after the vesting date:

(Sale price-vesting price) x shares=capital gain (or loss)

At vesting, federal, Social Security, Medicare, state, and municipal taxes are withheld from shares. Your corporation may give a choice of tax payment methods or require one.

Three common ways to pay RSU taxes:

  • Your corporation “tenders” the withholding tax shares.
  • You fund the withholding and own all vested shares.
  • All vested RSUs might be sold, creating a cash incentive connected to your company’s stock price.

Even if you incur a capital loss, you’ll still owe income tax based on the vesting price.

When a firm stock reaches zero, your taxable income matches your capital loss. As income is taxed at greater rates than capital gains (losses), you’d lose money on your “bonus.”

How is RSU income taxed?

Most employers don’t withhold taxes based on your W-4 rate rather use the flat IRS rate for supplemental wages. 2022 rates are 22% on supplemental wages up to $1 million and 37% above that.

If your RSU income is taxed above 22% when you pay your taxes, you may owe additional taxes. If you anticipate being in this situation, you may want to withhold more federal taxes from your paycheck or save money for your tax payment.

Common Tax Planning for RSUs

RSU tax planning is simpler than stock option tax planning. When shares are delivered under RSUs, often at vesting, you must pay income taxes.

Share Withholding: In the year that the shares are transferred to you, the value of the stock at vesting will be shown on your W-2. The corporate plan you use might deduct taxes (federal, state, local, Social Security up to the yearly maximum, and Medicare). Some plans, at least for U.S. employees, allow you to “surrender” an equivalent value of shares in order to pay the withholding taxes. Because you use company shares rather than cash to satisfy your tax responsibilities, share surrender not only allows you to avoid paying taxes in cash but also helps you diversify your stock portfolio.

Warning: You should account for this variation in the amount of taxes you will ultimately owe when preparing your taxes. You might need to set aside the additional taxes to pay when you submit your yearly return or make an anticipated tax payment for the quarter in which vesting happened.

RSU Taxation for Non-U.S. Employees: Outside of the United States, the taxation of restricted stock units occurs at a similar time. Capital gains tax is imposed on the eventual sale of the shares, while income and social taxes are calculated based on the value of the shares at the time of delivery (not grant). The Global Tax Guide, which describes the specific tax treatment in numerous nations throughout the world, is available in the Schwab Equity Awards Center.

Taxes If You Move to Another Location: If you are a U.S. employee and intend to relocate to or from a state that levies no income taxes, research the tax regulations of each state. Even if you don’t dwell in the state when the award is taxed, many states tax RSUs if you work or reside there for a portion of the vesting term. If you relocate, request that the payroll division of your business switch tax withholding from one state to another.

If you switch between countries during the vesting term, the tax apportionment will be comparable. You might be required to pay your former home country tax at the time of share distribution following vesting in proportion to the amount of time throughout the vesting period that you spent working there.

Wash Sale Rules: The wash sale rules in the U.S. tax code prevent you from deducting a tax loss associated with the sale of stock if you buy essentially identical stock within a period starting 30 days before or ending 30 days after the sale. Ask a tax expert whether the grant or the vesting is regarded a “purchase” that may defer recognition of the loss and carry it forward to the shares issued at vesting if you intend to sell other business stock at a loss.

Financial Planning Considerations

The vesting date, when you take the income hit, is a crucial date to take into account while budgeting for RSUs.

What Leads to Vesting: Time-based RSUs vest only as time goes by. You get the stock if you’re still working on the vesting date. Some performance objectives, such as hitting a target stock price or total shareholder return on earnings-per-share targets, could make vesting dependent upon them or expedite it. Make sure you are aware of the vesting triggers.

Depending on the pre-IPO company, vesting may be influenced by both the duration of employment and a liquidity event (i.e., the initial public offering).

Warning: Be prepared if your employment stops for any reason by being aware of your options (voluntary or involuntary). Know what will transpire in the event that your company is acquired, including whether the award will be canceled, whether it will continue to vest and convert to the buyer’s shares, or whether only a portion of it will.

Sell Choices: Deciding what to do with the stock once it vests involves making both an investment and a tax choice.

You must choose whether to keep or sell RSUs once they have vested. The shares can be a great source of money whether you need money for personal necessities or large purchases (like a home or college tuition). Selling the shares will almost certainly assist you in diversifying your holdings because it is common for employee portfolios to be overweight in company stock, which is typically the riskiest asset. If you frequently have access to sensitive information about your company, you might want to think about establishing a Rule 10b5-1 trading plan to make a planned stock sell easier.

Retirement Preparation

Consult the plan’s or the grant agreement’s conditions if you intend to retire before vesting. All or a portion of the award may vest upon “qualified” retirement (as that term is defined in the stock plan), taking into account your service up until the retirement date. The answer to this query will impact your retirement cash flow and any income-shifting plans. It could be possible for you to pick a retirement date that will optimize your eligibility for these benefits.

Estate Planning

Like any other asset you hold, RSUs that vest upon your death are included in your estate when you pass away. Even to family members, trusts for the benefit of family members, or family limited partnerships, RSUs often cannot be transferred for estate planning before they vest, however customs are subject to change. Find out if you can name a beneficiary to receive your RSUs if you pass away before they vest.

UNIQUE TAX PLANNING STRATEGIES FOR RSUs

Using RSUs in OPTIMIZING tax-deferred contributions

Contributing to a 401(k) or IRA reduces your current-year taxable income. For those with vested RSUs but limited cash flow, there’s an additional planning option.

If you’re holding RSUs to defer taxes on profits, you can utilize the selling proceeds to max out tax-deferred accounts and offset your tax burden (in addition to diversifying your investment portfolio).

The maximum employer 401(k) contribution for 2022 is $20,500, plus $6,500 for individuals 50 or older. Maximum IRA contribution is $6,000, plus $1,000 catch-up.

Example:

The cost basis for Executive A’s 2,000 vested RSUs is $5/share. He’s owned the shares for more than two years and is contributing $11,000 to his employer’s 401(k) plan. He has no IRA.

He’s in the 15% and 24% capital gains and income tax brackets.

Executive A may sell 2,000 shares for $20,000, owing $1,500 in capital gains tax ($5 gain x 2,000 shares x 15% tax rate). Then he could max out his 401(k), saving $2,280 in taxes ($9,500 x 24%). With the rest, he could contribute up to $6,000 to a regular IRA and decrease his tax burden by $1,440 ($6,000 x 24%), subject to income phaseouts.

This technique might save Executive A up to $2,220 in taxes in the current year ($3,720 saved – $1,500 in capital gains tax) while allowing him to diversify his investment portfolio and save in a tax-advantaged account.

Deduction Bunching

This strategy is for you if you’ve maxed out your retirement accounts.

The 2017 Tax Cuts and Jobs Act increased the standard deduction to $25,900 for couples and $12,950 for individuals, making deduction bunching more relevant for itemizers.

Most Common Itemized Deductions:

  • Mortgage Interest
  • Charitable donations
  • Medical expenses

Deduction bunching is squeezing as many deductions as possible into one tax year to boost itemized deductions and reduce taxes.

Because RSUs are taxed as income in the year they vest, consider bunching deductions to offset part of the revenue.

Because SALT deductions are capped at $10k and mortgage interest can’t be bundled, charitable donations and medical costs present opportunities.

Starting in 2020, medical expenditure deductions are limited to “eligible unreimbursed medical care expenses exceeding 10% of adjusted gross income.” If significant medical expenses take you over the 10% threshold, you can prepay upcoming charges to shift as much of the deduction into the current year as possible.

Say for example you are due for braces. Your orthodontist may allow you to pay for braces over two years. If you’re above 10% AGI and can afford it, pay the whole cost upfront to group the expenses and pull the tax benefit into the current year.

The bunching method results in an additional $20,000 tax deduction in the current year (since you’ll use the Standard Deduction) and saves you almost $4,500 on your tax bill now.

Same with charitable giving. In a high-income year driven by RSUs, you can pull forward five years of charitable giving to decrease your tax burden. 

Donor Advised Funds (DAF)

Suppose you can forward five years of philanthropic donations. Like many, you’d rather give over five years and get a tax deduction. How will you achieve this?

Use the Donor-advised funds (DAF) strategy!

A DAF works as follows:

  • Create a charitable trust in your name.
  • Contributions to the fund are tax deductible in the year they are made.
  • Invested assets can grow tax-free.
  • Grants to charities can be made at any time in the future.

Furthermore, highly appreciated securities can be used to fund a DAF, resulting in not only a tax deduction in the funding year but also an exemption from capital gains tax on the donated securities.

Essentially, using a DAF allows you to combine the charitable bunching strategy with the ability to give as you normally would. You must fund the account upfront, and donations are irreversible. After funding a DAF, you must donate the money.

 

FAQs for RSUs

What is an RSU Offset?

RSU stock income is reported on your pay stub after vesting. The RSU Offset may be shown in the deduction line since you don’t receive cash in your pay at vesting but instead in your brokerage account when the shares are sold.

Are RSUs taxed twice?

No. The value of your shares at vesting is taxed as income, and anything above this amount, if you continue to hold the shares, is taxed at capital gains. The second taxable event (the capital gains tax) doesn’t apply to any portion you have already paid income tax on.

At what tax rate are RSUs taxed?

RSUs compensation is taxed at your ordinary-income tax rate. If you choose to hold your shares after they vest, any gain (or loss) is taxed as a capital gain (or loss).

When is RSU income taxed?

RSU income is taxed when your shares vest. Your employer will typically withhold taxes at the federal supplemental wages withholding rate, which is 22% up to $1 million of income and 37% for wages in excess of $1 million.

Is RSU income included on your W2?

Yes. At vesting, RSU income is reported on your W2, and any taxes withheld are included as well.

Are RSUs better than Stock Options?

RSUs are like options with a $0 strike price. So, a RSU share is always at least as valuable as one stock option. However, because of this, companies typically grant more shares of options than RSUs. A rule of thumb for Technology employees is that four Options are roughly equivalent to one RSU share.

Either of these strategies could work for you, but they both have risks and costs. They may, however, assist you in deferring the sale of your RSUs until a more favorable time comes. That’s why it’s important that you discuss this with a credible Tax Advisor who can help you:

  • Calculate RSU vesting and tax consequences

  • Check if your RSU tax withholding is enough (and make a plan if not)

  • Determine how much company shares you want to hold to drive your RSU selling plan.

  • Maximize tax-deferred accounts and charitable giving with RSU income.