Fundamentals of RSUs, Tax Ramifications & Strategies for Maximizing their Value

A&I Wealth Management > Blog > Investment Advice > Concentrated Equity > Fundamentals of RSUs, Tax Ramifications & Strategies for Maximizing their Value

Owners of RSUs looking at a tablet with info about their restricted stock units.Restricted stock units (RSUs) and performance-based restricted stock units (PSUs) are a sort of equity compensation that is frequently given to employees of technology companies. They’re utilized as additional compensation in addition to a normal salary in the form of stock ownership. RSUs may be a valuable type of compensation and provide several planning options. However, if you don’t know how they work or what these possibilities are, you’re probably left wondering what to do with your RSUs. This article will look at the fundamentals of RSUs, tax ramifications, and strategies for maximizing their value!

Takeaway: When you receive RSUs, they will typically have a set number of restrictions. This means that you can’t yet sell the units, but they will vest over time. When it comes to deciding what to do with your RSUs, it’s important to consider both the potential risks and tax consequences.

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The tax information contained in this blogpost is general in nature.  Always consult an attorney or tax professional regarding your specific legal situation.

What are RSUs or Restricted Stock Units?

RSU stands for restricted stock units. These units represent a promise from your employer to pay you in the future with stock in your company, based on a certain formula. RSUs typically have restrictions placed on them while they’re still “outstanding” which means that you can’t sell them quite yet. In exchange, their value is discounted compared to what they would be worth if there were no restrictions.

In order to give employees an incentive to work hard and stay at their company for the long term without forcing employers to increase cash compensation every year, companies started using restricted stock units as equity compensation instead of just giving out additional shares of common stock. The main difference is that RSUs are taxed upon vesting. If the company gave you stock, the stock would be taxed at your income tax rate on the date they gave you the stock.

What to do with RSUs?

Once you are awarded RSUs, the next step is to determine when they vest. A good rule of thumb is to create a vesting schedule. On the year the RSU vests, you will pay income tax on the fair market value of the stock. The company may give you a choice to either withhold taxes or not. In this case, you allow them to withhold enough shares to pay the income tax burden, and then you receive the rest of the shares. This is the most common choice.

On the other hand, you may want to keep all the shares and pay your tax burden on your own, when taxes are due. This is less popular because the tax bill can be substantial. If our clients are given a choice, we usually see them choose to have the stocks withheld to cover the tax burden. This gives you two benefits. First, you are able to reduce the amount of your net worth tied up in your company stock. Second, you don’t have to worry about your income tax burden.

After the RSU vests, you own stock. You can sell it or keep it.

What taxes do I have to pay on my restricted stock units?

The taxes you have to pay are two-fold. First, determine how many years it will take before your RSUs are “vested” and if there are any tax withholding requirements set by the company. When RSU or PSU vests, it is taxed as income, at your income tax rates. In most cases, the company withholds shares to pay the income tax burden. See nearby question and answer on how much is withheld to pay taxes on RSUs or PSUs.

Second, after the RSU vests, you will own company stock. At that point you can either sell or keep the stock. Your taxes owed at that point depend upon whether the stock increases or decreases in value, and how long you own it. For many clients, the best choice is to sell the stock as soon as it vests. This way, if the stock price is exactly the same as the vesting price, there is no further tax burden.

Once you know this information, you can consult with a qualified tax professional about your specific situation. They will determine what taxes you owe.

How much is witheld to pay taxes on RSUs and PSUs that vest?

A company will withhold 22% of the shares for taxes if they estimate your compensation annualizes at less than $1 million per year. The company will withhold 37% if it is over $1 million. Additionally, the company will withhold your share of the FICA taxes, with is just under 8%. The company may also withhold state income taxes, which vary by state.

Importantly, the withholding is based off this single vesting date. It can easily cause the company to withhold more for taxes than you need to. An example might make this easier to understand. Let’s say $50,000 in RSUs vest and your company pays you every two weeks. You receive 26 paychecks per year, so it looks like you are making more than $1 million, so the company withholds the 37% Federal rate. If you are in a state with a graduated income tax bracket, you could pay state income taxes at the highest rate, plus FICA taxes.

Also, it might be OK for the company to withhold more shares for taxes than you need. It is often the case that the prudent financial decision is to sell the stock immediately after the vesting date. For more on this, see the nearby question and answer about selling the stock.

What are ways I can save tax dollars with RSUs?

There are several ways you can use your RSUs to help save you some money when it comes time to pay the IRS! If you would like more information on how RSUs work and ways to maximize your benefits before you leave your company, connect with one of our financial advisors near you or give us a call at +1 303-690-5070!

What are some tax planning opportunities of RSUs?

If you have a long-term view on your investments, one great opportunity is to sell your vested RSUs early so that you can avoid higher taxes in the future. For example, let’s look at a common vesting plan. Assume you have an RSU plan with a 3 year vest. Every year you are given new RSUs. This means that after working there for three years or more you have a series of RSUs that will vest each and every year. Upon vesting, the RSU becomes a share of the company. At that point, any gains are capital-gains, either long-term or short-term, as explained nearby.

Try to sell some of your RSUs before leaving the company. That way, you can reduce the amount of your assets tied to your company. Plus, you can use the proceeds to pay for the taxes owed on other RSUs as they vest. Additionally, set aside money for quarterly estimated tax payments. If you are in a situation where the vesting RSUs are substantial, then the IRS is going to want you to pay estimated taxes during the calendar year when they vest. Otherwise, you face a penalty tax on top of the income tax!

Finally, consider other forms of equity compensation from your employer. If you have an Employee Stock Purchase Plan (ESPP) or stock options, then you may want to speak to a CFP professional about which of these is best for you to hold, sell or give away for your unique situation.

See more here: Concentrated Equity Strategies.

Should I sell a PSU or RSU after it vests?

Deciding to sell the stock is usually full of emotion in addition to financial consequences. For some executives, the employment contract requires you to maintain a certain dollar amount or number of shares in the company stock. Beyond that, you should talk with your financial planner.

For an employee who is not handcuffed by being required to own company stock, the prudent decision is usually to sell the stock and invest in a diverse portfolio of investments, appropriate for your financial situation. Talk with a financial planner and make a plan. Then after the plan is made, you can decide whether or not to keep more of your personal net worth tied up in your company’s stock than necessary.

Employees sometimes feel conflicted because they want to see their assets grow, and believe their company will grow faster than the overall market. On the other hand, they do not want to take on risk and may not appreciate the amount of risk tied up in a single company. For more on how to make a plan to solve for your PSU or RSU concentrated risk: Concentrated Equity Strategies.

What if I leave my company early and keep my RSUs?

If you leave your company before your RSUs reach 100% vesting and there is still a restriction period, any unvested RSUs will be forfeited and no longer available to you. However, if there were vesting requirements such as achieving a certain seniority or staying at the company for 3 years or more, your company may waive the vesting requirements. Then you would still have to pay taxes on those RSUs. For example, if you had 5 years left until 100% restricted stock units (RSU’s) were yours to keep then you left the company after only 1 year, you would forfeit them.

What are the tax consequences if I leave the company and sell my RSUs?

If you leave your company, whether it be by quitting or being fired, your RSUs are considered “forfeited” by the employer. You do not have to pay federal taxes, but neither will your receive any unvested RSU.

Even though you no longer work for the company, you still owe capital gains taxes on any vested RSUs you may own from prior years of employment. The only difference is now it’s up to you to pay the taxes, with no help from your former employer. Vested RSUs are now shares of your former employer.

Here are the latest capital gains tax rates for the sale.

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How do taxes work on vested RSUs and PSUs?

Once an RSU or PSU vests, it is actually no longer an RSU or PSU. It is a share of common stock. If you sell that stock then you have either a capital gain or a capital loss on that investment. The gain is a long-term gain, subject to lower tax rates, if you held the stock more than a year after vesting. It is a short-term gain if you held it for less than 365 days.

Conversely, if the share price declines between the vesting date and sale date, you have either a short-term or long-term loss, depending upon how long you held the stock after the vesting date.

Importantly, it is the vesting date that determines your capital gains tax rate. It does not matter when the RSU or PSU was granted to you, only the vesting date. On the vesting date, the PSU or RSU became a common stock.

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About the author

Karl Frank, Certified Financial Planner ®, MSF, MBA, MA, is the President of A&I Financial Services LLC, a local business that specializes in wealth management, insurance planning, and retirement planning. Karl cares for business owners and the businesses that care for them. Learn More about Karl.