10 Things You Should Know About Your RSUs
10 Questions You Should Be Able to Answer About Your Restricted Stock Units (RSUs)
1. What is a Restricted Stock Unit (RSU)?
A Restricted Stock Unit, commonly referred to as an RSU, is a right awarded by a company to an employee to a specific number of shares of the company’s stock once the employee has met the conditions of the award. The most common condition of RSUs is remaining employed with a company for a stated period of time.
An important thing to note, RSUs are not Restricted Stock Awards (RSAs). Even those these two things sound very similar, they are different. Make sure you do not confuse the two.
2. What happens to RSUs when they vest?
Vesting occurs when an employee meets the underlying conditions of the grant. At that time, the employer gives the employee the promised number of shares of stock in the company, and the related taxes must be paid (discussed in more detail below). If an employee leaves or is terminated before the conditions are met, then the shares are never transferred to the employee because vesting never occurred Once the RSUs vest, the employee now owns shares of the company.
3. When will my RSUs will vest?
The vesting schedule should be disclosed in the Restricted Stock Unit Award Agreement, commonly referred to as the grant agreement. This agreement will list the totally number of RSUs awarded, the dates when the RSUs will vest and other important terms of the grant.
4. What is the typical vesting schedule for RSUs?
There are generally 3 types of vesting schedules for RSUs: cliff, graded and hybrid.
Cliff Vesting is an “all-or-nothing” type vesting schedule. If an RSU has a 3-year cliff vesting schedule, then 100% of the RSUs will vest at the end of year 3.
Graded Vesting is a more gradual vesting schedule where portions of the total grant vest over time. If an RSU has a 4-year graded vesting schedule where the employee vests 25% of the grant per year, then the employee will earn a quarter of the shares each year.
Hybrid Vesting is a combination of the two. Typically, an employee will cliff vest a portion of the RSU grant, and the remaining RSUs will vest on a Graded basis over the remainder of the term. As an example, over a 4-year vesting period, 50% could cliff vest at the end of year two, and the remaining 50% will vest in equal portions over the following 2 years.
5. How are RSUs taxed?
RSUs are taxed as they vest. The employee will recognize income equal to the number of shares vested multiplied by the share price at time of vesting. For example, if an employee has 10 RSUs vesting, and each share of stock was valued at $100 at time of vest, then the employee would recognize ordinary income of $1,000. This income would be subject to not only Federal and State income taxes, but also Social Security (up to the annual limit) and Medicare.
6. How will the taxes be paid when the RSUs vest?
This is an important question. If the company is giving the employee shares, and the employee needs to pay taxes on those shares, how are the taxes actually paid?
Generally speaking, the company is required to withhold all taxes (federal, state, social security and Medicare) when the RSUs vest. However, because the vesting is essentially a cashless transaction, cash needs to be generated to pay the tax. This problem is usually resolved by the employer selling enough shares to cover the taxes, then giving the employee the remaining shares of stock.
7. What is the RSU tax rate?
Most companies will withhold federal income taxes using the federal supplemental wage withholding rate, which is 22% on total income up to $1M and 37% for income over $1M. However, if the employee is a high-earner or is married to a high-earner, the actual income tax rate could be significantly higher. (The top federal income tax rate at the time of this article was published is 37%.). Therefore, a high earner with a significant amount of vesting RSUs could be in for a nasty income tax surprise come the next April 15th if they are not adequately prepared.
8. Can I sell the stock when my RSUs vest?
Yes, you can immediately sell the shares when they vest. You will recognize the income and pay the related taxes that the vesting RSUs creates. But since you have effectively sold the shares for cash, there will be no other income tax consequences and you will no longer hold the shares.
If you can be classified as an insider, consult with your company’s legal team to evaluation your
9. Once I own the shares, how will they be taxed?
The shares are subject to the same tax treatment of any other stocks you own. The sale will result in a capital gain, and the gain will be classified as short-term or long-term depending upon on long you hold the shares. If the shares are held for less than a year, the gain will be taxed at short-term capital gain (effectively ordinary income tax) rates. Shares held over a year are taxed at the preferred long-term capital gain rates. The holding period begins when the shares vest.
The amount of the gain recognized is the sales price of the shares less the amount of income that was recognized when the shares vested. If the RSUs vested over a number of years, you will need to keep track of the income earned on each tranche. When you sell, you can determine which tranche is most consistent with your income tax planning strategy.
10. Now that my RSUs have vested, what should I do with the shares that I now own?
This depends upon your own personal financial plan. (You can read more about what a financial plan is here.) Having too much of an employer’s stock can be very risky because not only are you dependent upon the company for your employment, but you may also develop a highly concentrated stock position relative to your net worth. If something happened to the company, not only could you lose a primary source of income, but your net worth could take a significant hit too.
A question to ask yourself is if you had the cash that the shares were worth, would you use all of that cash to purchase the shares. For example, if the shares were worth $100K, would you use all of the cash to purchase shares in your company? If the answer is “No way!” then you should probably look at strategically selling shares to align your asset allocation to your financial plan. If the answer is “Yes,” then just be mindful of the concentration risk that may develop. If the answer is, “I don’t know,” schedule a time here, and we can help you figure it out.
About the author:
JP Geisbauer is a Certified Public Accountant and a Certified Financial Planner ®. He is the founder of Centerpoint Financial Management, LLC, a financial planning, investment management, and income tax planning firm located in Irvine, CA. If you have specific questions regarding your situation, please schedule a complimentary 30-minute call here.
Disclaimer:
This article is for general information and educational purposes only. Nothing contained in this article constitutes individual financial, investment, tax, or legal advice. Before taking any action on any topic discussed in this article, please consult with your own financial planner, investment advisor, tax professional, and/or attorney for advice on your specific situation.