Today, we are going to explore Restricted Stock Units (RSUs). Many private and publicly traded companies grant RSUs to employees as part of their compensation plan. RSUs incentivize employees to stay with a company for several years while also working toward the common goal of pushing a company’s stock price higher. According to a 2020 report from Foley, “RSUs have been used for decades, but their popularity has increased dramatically in the last 10-20 years. In a recent survey of 325 companies, 72% reported using RSUs in their long-term incentive compensation programs compared to only 47% ten years earlier and 4% 21 years earlier”.
RSU grants are considered “restricted” because they are subject to a vesting schedule. Usually, in order to receive all of the shares, you must stay with the company for several years. Each vesting period is determined by the employer and typically comes in 2 forms. Graduated vesting or Cliff vesting. Graduated could be 25% per year over 4 years or 20% per year over 5 years. Cliff vesting would mean ALL your shares vest in a particular year.
To understand RSU vesting, let’s look at an example. In this example, we will assume that Adam just received an employment offer from ABC Company to start working on 1/1/2021. As a part of his offer letter, ABC Company decides to grant Adam 500 shares of restricted stock based on a 5-year vesting schedule. Therefore, Adam will receive 100 shares every one-year anniversary for the next 5 years, so long as he stays with the company.
Tax at grant
When you are granted RSU’s, there are no tax implications. You would pay tax if you elect a section 83(b) (we will be writing a separate blog on this).
Tax at vesting
Upon vesting (also known as “date of delivery”), the fair market value of the stock is treated as taxable compensation. Taxable compensation is subject to Federal Taxes, Employment Taxes, Social Security/Medicare, and State/Local taxes. Note that taxes are owed whether the stock is sold or not. Future performance of a stock is never certain but for this example we are going to use $22 per share after 1 year of employment. In the above example, Adam would owe ordinary income of $2,200 (100 shares multiplied by the $22 stock price at vesting) on the 100 shares that vest after one year of employment.
Tax at sale
In addition, if Adam decides to hold the stock after it vests and then sell his shares, any increase above the vesting price would be considered a capital gain.
Capital gains come in two forms:
• Short-term capital gains: an investment you hold for less than one year is taxed as ordinary income
(the same rate as wages- up to 37% under current law).
• Long-term capital gains: a more favorable capital gains rate is applied to an investment you hold for one year or more
(as low as 0%, up to 23.8% max).
If Adam sells the stock within one year of the vesting date, any price increase above $22 vesting price would be subject to short-term capital gains. Let’s assume that Adam decides to sell his 100 shares 11 months after the vesting date. At this time, ABC Company stock is worth $30 per share. Because he did not hold the stock for one year after vesting, Adam would owe short-term capital gains (taxed as ordinary income) on $800 (($30 current price – $22 vesting price)*100)). If Adam would have held the stock for 12 months or longer before selling, he would be subject to more favorable tax rates. In this case, he only had to wait another month before benefiting from long-term capital gain rates. Here are the 2021 long-term capital gains rates according to current law.
Once RSU shares vest, the taxable income on your paystub will equal the number of shares multiplied by the vesting price. Typically, employers will automatically withhold additional taxes from your normal salary so that you aren’t hit with a surprise tax bill come April 15th. Some companies even allow you to “tender” shares. Tendering your shares means that you sell a portion of your shares back to the company in order to cover the taxes. This may be a good option for those who don’t want to go out-of-pocket for the tax liability.
It’s not uncommon for RSUs to account for most of an individual’s net worth. Employees often have a hard time selling company stock either due to an emotional tie or a biased outlook on the company. This can lead to ignoring risks and only focusing on the company’s positive attributes. When it comes to investing, it’s important to take an unbiased approach and to double check any potential blind spots. A good rule of thumb is to have less than 10% of your net worth held in your company’s stock.
RSUs can help you build your wealth through your employer outside of typical retirement accounts. More and more companies are turning to RSUs to reward and retain their workforce. However, it’s important to remember that timing is critical in handling RSUs since tax implications can often catch employees by surprise. Be on the lookout for an upcoming blog where we will talk about a Section 83(b) election as an effective way to minimize a future tax liability with Restricted Stock Units.
If you have any questions, please reach out to our team here at Taylor Hoffman!
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