By: Edward J. Leach, MBA, CFP®
What is a Restricted Stock Unit (RSU)?
A Restricted Stock Unit (RSU) is a form of compensation that some companies use to reward their employees. RSUs represent a promise to give an employee a certain number of shares of company stock at a future date, typically once certain conditions are met, such as a specified vesting period or performance goals. RSUs are a common form of equity-based compensation used in publicly traded and private companies.
What are the tax implications of Restricted Stock Units (RSU)?
Grant Date: When you receive RSUs, it is not considered taxable income at this stage because you don't own the shares yet. The IRS does not treat the granting of RSUs as a taxable event.
Vesting Date: RSUs usually have a vesting period during which you must continue to work for the company or meet certain performance conditions. Once the RSUs vest, they become taxable income.
Taxation at Vesting: When the RSUs vest, the fair market value (FMV) of the company's stock on that date is included in your taxable income for the year, and your employer will typically withhold a portion of the shares or cash to cover the income tax liability. This amount is subject to ordinary income tax rates.
For example, when they vested, you were granted 1,000 RSUs at a company with a stock price of $50 per share. The FMV of the vested RSUs would be $50,000. If your marginal tax rate is 25%, you would owe $12,500 in taxes on the RSUs ($50,000 x 25%).
Holding the Shares: The shares are yours to keep once you've paid the income tax on the vested RSUs. You can hold onto them, and any future gains or losses will be treated as capital gains or losses when you sell the shares.
Selling the Shares: When you decide to sell the shares acquired through RSUs, you will incur capital gains or losses based on the difference between the sale price and the FMV of the shares at the time of vesting. If you hold the shares for more than one year after the vesting date, any profit is typically taxed at the long-term capital gains tax rate, often lower than the ordinary income tax rate.
What should I do once my Restricted Stock Units (RSU) vest?
One of the first questions we always ask clients who receive RSUs is:
"If you were to receive a cash bonus from your employer and not RSUs, would you buy your company's stock with your after-tax proceeds?"
Usually, the answer is no. At that point, it's an easy answer to sell the stock upon vesting and leverage your disciplined savings plan to figure out how to allocate the funds. Maybe bonuses are earmarked for special vacations, home renovations, building up a cash reserve, making Roth IRA contributions, or increasing your Employer 401(k) contributions - the options are endless.
If the answer is yes, I would buy my company stock. At that point, we would execute a risk assessment to assess how much of your financial picture is exposed to the fate of your employer.
It could be the next Amazon, Lehman Brothers, or somewhere in between, but make the decisions with eyes wide open and without emotion.
Ed Leach, CFP®, MBA, is a Partner and Wealth Advisor at HIGHLAND Financial Advisors, LLC in Wayne, NJ, and works directly with clients advising them on their financial planning and investments. Ed’s work focuses on the unique needs of business owners, helping them extract value from their businesses while creating efficiencies in their business and personal financial plans. He is also a member of NAPFA, which is dedicated to serving fee-only advisors.