Restricted Stock Units (RSUs) are a type of equity compensation reserved for employees. RSUs give employees ownership in the company they work for and allow them to participate in the company’s success. These RSUs can become very valuable and may represent a growing portion of your investment portfolio over time. It is important to incorporate RSUs in your financial planning to ensure you are making the most of this investment. In this post, we will talk about what RSUs are, their tax impact, and some options for what to do with them.
What is an RSU?
A Restricted Stock Unit is a right to receive a share of company stock once certain conditions are satisfied, such as staying with the company for a certain period of time. Once these conditions are satisfied, the RSUs “vest” and you receive the stock shares as compensation.
For this post, let’s say you are an employee of Stryker Corporation and were granted 90 RSUs which vest 1/3 per year starting a year from now.
These are some key terms to know about RSUs:
Once you are awarded RSUs, they do not become shares of stock that you own until the conditions for vesting are met. Often, these are related to certain time periods of service with your company. For example, if you work for the company for an additional two years, then certain RSUs will vest. It is common to see an RSU award vest over a multi-year period. Vesting can also be based on hitting certain performance targets.
The grant date is the date you are awarded the RSUs and they are pledged to you. However, you do not own the shares until they have vested.
In our example, you were granted 90 Stryker Restricted Stock Units. However, at this point you do not yet actually own any shares of stock.
The vest date is when you have the right to receive the actual shares of stock. This is also the point when the shares are reported as taxable compensation, and taxes are due. This can be handled in different ways, which are described below.
In our example, as long as you remain employed by Stryker for one year, 30 RSUs will vest and you will receive 30 shares of stock at that point. If you remain employed by Stryker for an additional year, you will 30 more shares and then an additional 30 shares following another year of employment.
In some ways, the tax consequences of RSUs are straightforward. There is no tax imposed when the RSUs are granted. On the vesting date, the value of the RSUs that have vested is treated as ordinary income and will be subject to federal and state income tax as well as social security and Medicare taxes.
Once your RSUs have vested, you own them just like any other shares of stock. Your cost basis is the amount that was reported as taxable compensation upon vesting, and your acquisition date is the vesting date. From that point forward, any gains or losses upon sale receive capital gains treatment: short term gains (held less than one year) are treated as ordinary income, while long terms gains (held more than a year) receive preferential long term capital gains tax treatment.
In our example, let’s assume that the price of Stryker stock is $300 per share when the first tranche vests one year from the grant date. Thus, the value of the RSUs is $9,000 (30 x $300), so you will have an additional $9,000 of ordinary income reported on your payslip. At this point (assuming you have elected to keep all the shares), you will own 30 shares of Stryker stock with a cost basis of $300 per share.
What Should You Do With Your RSUs?
Sell All Your Shares
Depending on how much company stock you already own or are expecting to receive, you may want to sell your shares to reduce your exposure to Stryker. If you sell shortly after vesting, you can likely do so without significant further tax impact.
In our example, this means you would have $9,000 less the taxes withheld deposited into your bank account.
Sell Enough Shares to Cover Your Tax Bill
Many employees elect to sell just enough shares to cover the tax bill resulting from the vesting of their RSUs. This solution leaves you with some company stock, and means that you do not have to pay the tax bill out-of-pocket.
In our example, perhaps the taxes on $9,000 are $3,000. If so, you’ve sold 10 shares and 20 shares are transferred into your investment account.
Keep All Your Shares
This decision leaves you with the most exposure to Stryker in your investment portfolio. To cover the cost of taxes from the vesting of the RSUs, you will need to come up with the cash from your own pocket.
In our example, you would write a check to the company for $3,000 and all 30 of your shares would be transferred into your investment account.
Restricted Stock Units are an additional form of compensation that can be very valuable to you over time. It is important to plan for them as they impact both your investment portfolio and your tax liability. The best course of action can differ for each person depending on their overall situation and financial goals. We routinely help clients navigate the best course of action for them. If you would like to hear about how we work with clients to evaluate their stock exposure, reduce their tax burden and purposely plan for their goals, please schedule a call.