Restricted Stock Units

Restricted Stock Units (RSUs) work like a bonus paid via stock instead of cash.

Like a cash bonus, you owe taxes on the bonus and this is added to your W-2 (ordinary) income, but sometimes the company can help you out by withholding a percent of the bonus so you don’t have an unexpected tax payment the following spring.

The Restricted part is that your employer will likely add a vesting schedule as an incentive for you to stay at the company and help it grow. The IRS agrees that you shouldn’t pay taxes on a stock bonus if you haven’t actually received it, so you only pay taxes on the amount that vests. There may also be restrictions on when you can sell shares (blackout periods), such as only 2–4 periods per year after quarterly earnings announcements.

The Units part is that these are not technically shares of stock when you receive the grant. The track the exact value of the stock of the company and you receive shares of stock when they vest, but they may or may not receive dividends or have voting rights.

The schedule for RSUs of publicly traded companies usually follows:

You receive a grant of RSUs as an award for your exemplary work. They vest over a few years because the company wants to keep you around to keep doing great work. You receive a grant notice and possibly choose a withholding option (or do nothing and end up with the default option).
These shares usually begin vesting one year from the grant date over the following three of four years.
- (There is a wider variety of variety of vesting schedules among different companies. Some start immediately, some vest quarterly or semi-annually instead annually. Some have a larger amount vest the first time, with lesser amounts the following years, e.g. 50% after one year, 25% on the second and third anniversaries. etc.)
You can’t sell these units before they vest, so you have not received anything, so you do not owe any taxes.
Upon the first vest, you now owe taxes based on the value AT TIME OF VESTING. The value is the number of shares vesting x the current market price of the company stock.
- If the stock price has gone up or down, you still owe taxes on the value at the current market price, not the value from the grant date.
The default withholding option is to sell some of the shares that just vested to fund the withholding for the taxes owed on all the vesting shares.
- If you received a grant of 400 RSUs, with 25% vesting on the first anniversary, you will see 100 shares vest with ~41 shares immediately sold to cover the taxes. You have 59 shares remaining you can sell (pending blackout periods).
  - Withholding rates vary by state and company. An example for a resident of California, for 2018 moving forward under the Tax Cuts and Jobs Act, could be:
    22% Federal
    6.2% Social Security
    1.5% Medicare
    10.2% CA-State
    1% CA-SDI
- You owe taxes on the W-2 (ordinary) income for the entire 100 shares that vested, not just the 59 shares you have remaining.
  - If your marginal tax rate is over 22%, it is possible the shares sold do not cover the taxes owed. You may owe additional taxes the following spring, or your refund is smaller if the withholdings from your regular salary cover the difference.
- You do not need to sell the shares to cover the taxes. You can choose to keep all the shares and increase the withholding from your pay check or make quarterly payments to the IRS. Selling shares to cover the taxes is easier and follows the idea of ‘the thing triggering the taxes pays for the taxes itself.’
You now hold the remaining shares with a cost basis equal to the fair market value at time of vest. These shares follow the same rules regarding capital gains and losses as other stock. If you wait a year before selling, any gain would be taxed as long-term capital gain instead of short-term capital gain (ordinary income).
- The shares sold to cover the taxes were sold on the same day as they vested, so there is no capital gain or loss.
- You can keep these shares at the custodian, transfer them to another custodian, sell and invest in a more diversified portfolio, sell to use for lifestyle expenses, etc.
One planning/investment decision to consider is that you already owe taxes on the shares at the time of vest and this establishes your basis. If you sold all your shares at that time, you do not owe any additional taxes for selling all your shares.
- In terms of your investment strategy and taxes, it is functionally the same as taking all the cash from the sale proceeds, depositing in a brokerage account, and buying shares of your company stock again.
- Choosing to remain invested in your company stock is a high-risk/high-reward strategy. Depending on your goals for the proceeds, it may be more prudent to determine what concentration risk you feel comfortable with and invest the remainder in a more diversified asset allocation.

The big difference for RSUs of private companies:

You still owe taxes on the amount of RSUs vesting at the time of vest EVEN IF THE COMPANY IS PRIVATE AND YOU CAN’T SELL ANY SHARES.
This may require you to make quarterly payments to the IRS out of pocket, withhold more from your salary, or owe more when you file your taxes the following spring.
- You can file an 83(i) election to defer the taxes for five years, which could help if you expect the shares to be sellable within five years.
Over the last several years, most companies granting RSUs of private companies have added a double-trigger vesting schedule. In addition to the normal time-based (or performance-based) vesting, the RSUs do not vest until there is some liquidity event, such as an Initial Public Offering (IPO) or a merger/acquisition by another company.
- This creates a situation where you may have several grants of RSUs that have achieved time-based vesting over a few years before liquidity. When the liquidity event occurs, all those RSUs vest at the same time, all adding to your ordinary income and probably pushing you into a higher tax bracket.
  - There may even be a situation, where the RSUs vest upon IPO, BUT as an employee you are still prevented from selling during the six-month lockup period. Now it becomes crucial to plan out in advance how you are going to cover the tax liability.

Do you have any questions regarding RSUs? Want to learn more?

Check out my answers on Quora or contact me.

Aaron Agte, CFP®, founder of Graystone Advisor, is a fee-only Financial Planner located in Foster City, CA, serving clients virtually in the Bay Area and across the country. He specializes in helping couples with stock options, RSUs, and other equity compensation.

@AaronAgteCFP