With RSUs, you are taxed when you receive the shares.
A restricted stock unit (RSU) is an award of stock shares, usually given as a form of employee compensation. Before the restricted stock units can be given to the owner, the person who gets them must meet certain conditions.
Employees get restricted stock units through a vesting plan and distribution schedule when they meet certain performance goals or stay with their employer for a certain amount of time.
Restricted stock units give employees a stake in their employer's equity, but until they are "vested," they have no real value. When the RSUs become valid, they are given a fair market value (FMV). Once restricted stock units have been earned, they are treated as income, and a portion of the shares are taken away to pay income taxes. The employee then gets the rest of the shares and can sell them if he or she wants to.
Most vesting schedules are based on time, so you have to work at the company for a certain amount of time before you can get your stock. There is also something called "cliff" vesting, in which 100% of the grant vests all at once after a certain amount of time has passed. The vesting schedule can also (or instead) be based on performance, such as goals set by the company or the stock market.
Most grants with restrictions that end after three to five years are called "graded-vesting grants." A graded vesting schedule can have regular vesting dates, or it can have different amounts of time between vesting dates: At companies that just went public, grants made before the initial public offering (IPO) may also need a liquidity event (the IPO) to happen before the shares can be used. After the liquidity event has happened, the shares become fully paid 180 days later. Almost always, vesting stops when a job ends. The only time this doesn't apply is when someone dies or becomes disabled. In these cases, vesting can continue or even speed up.
Understanding Restricted Stock Units (RSUs)
At the end of 2004, the Financial Accounting Standards Board (FASB) put out a statement saying that companies that give out stock options must record an expense in their books. This action made the playing field the same for all types of equity.
Because of scandals at companies like Enron and WorldCom in the middle of the 2000s, companies started to look at other types of stock awards as a way to get and keep good employees. RSUs, which used to only be given to managers in higher positions, became more common.
How do restricted stock units work?
In order for you to receive your RSUs, you have to meet the vesting conditions outlined in your RSU agreement. These restrictions on the award may be:
1. Time-based (e.g., you must stay at the company for a certain amount of time.)
2. Milestone-based (e.g., your company must IPO or be acquired, or you have to complete a performance milestone or project)
3. A combination of the two
Considering the Advantages & Disadvantages of a Restricted Stock Units (RSU)
Advantages of a RSU
RSUs give employees a reason to stay with a company for a long time and help it do well so that the value of their shares goes up. If an employee decides to keep their shares until they get their full vested allocation and the company's stock goes up, the employee gets the capital gain minus the value of the shares withheld for income taxes and the amount due in capital gains taxes.
There aren't any real shares to keep track of, so employers don't have to spend much on administration. RSUs also let a company wait to give out shares until the vesting schedule is done. This helps the company's shares last longer.
Disadvantages of a RSU
RSUs don't provide dividends before they vest. But an employer can pay equivalents to dividends that can be put into an escrow account to help pay withholding taxes or used to buy more shares. Section 1244 of the Internal Revenue Code says how tax is paid on restricted stocks (IRC). Restricted stock is included in gross income for tax purposes and is recognized on the date when the stocks become transferable. This is also known as the vesting date. The Internal Revenue Service (IRS) doesn't consider RSUs to be tangible property, so they don't qualify for the IRC 83(b) Election, which lets an employee pay taxes before vesting.
RSUs don't give the owner the right to vote until the employee gets actual shares at vesting. If an employee quits before the end of their vesting schedule, they lose any shares that they haven't yet earned.
Taxation of Restricted Stock Units
When RSU shares vest, they belong to the person who got them, and they are treated as taxable income. At that point, the value of the shares is counted as regular income and taxed in the same way. So, if 5,000 shares vest and the current price per share is $2, this is considered an income of $10,000 and ordinary income tax is due.
The company can figure out how much the shares are worth based on their face value or the value shown by the most recent round of financing.
Paying income tax on a stock grant can be hard for an employee because they would receive stock instead of cash and may not want to sell the stock. Some employers let their employees pay less or no taxes by giving back the same number of shares that they were given. Filing 83(b) or 83(i) elections is another way to deal with the tax debt.
By filing Form 83(b) with the IRS, the person who gets Restricted Stock can pay income tax on the shares when they are given instead of when they are received. An 83(b) election, which must be filed within 30 days of the initial grant, will bring on the income tax liability much sooner, but it will also usually mean that the tax burden is lower since the value of the stock at the time of the grant will likely be lower than when it is later received.
However, an 83(b) election is not available for RSUs, which are taxed under a different part of the tax code.
If the grant lets you, you can file an 83(i) election instead of an 83(b) election within 30 days of getting the shares. With this choice, the income earned at vesting is not taxed by the federal government for 5 years, or sooner if the company goes public or is bought. At the time of vesting, you may still have to pay Social Security, Medicare, and any state taxes.
Two qualifications for 83(i) eligibility are:
- The grant must specify that the RSUs are 83(i) eligible.
- The company must make these qualified grants to 80% of eligible employees in the same year.
When granted shares are sold in the end, short-term or long-term capital gains or losses are recorded based on the difference between the sale price of the stock and the price at which the recipient got the shares when the grant became effective.
Note: Due to the rules and complexities of 83(b) and 83(i) elections, employees should consult with a tax professional for the latest IRS rules and to determine the most beneficial course of action in their situation.
RSUs vs. Stock Options
Employees could receive stock options from their companies in addition to or in place of RSUs from the same employer. The following table provides an illustration of the primary distinctions between the two:
How to Sell RSUs: What You Need to Know
After you've earned your RSUs, you can either keep the stock or sell it. When you report your income and file your tax return, you will need to keep records and use extra forms.
You have to write down your "basis" in the RSUs, which is the amount you paid for the stock plus the amount that was included in your taxable income.
Find out if you made a profit or a loss on the investment by taking the basis and subtracting it from the amount you got when you sold the shares. File Schedule D and Form 8949 to report the sale.
- Schedule D of Form 1040 is a tax form used by individuals or corporations to report capital gains and losses to the IRS.
- IRS Form 8949 is a tax document you typically use to account for the difference in figures reported on Forms 1099-B and 1099-S, and your tax return. Form 8949 is filed along with Schedule D.
Frequently Asked Questions for RSU’s
If I leave the company, what happens to my RSU stock?
If you leave your company, you'll be able to keep the shares you've already earned.
When you leave a job where you have double-trigger RSUs, you usually lose any shares that you haven't earned through time. Also, your time-vested shares can lose their value before they "fully" vest (by meeting the milestone-based conditions of the second trigger, such as a liquidation event). Your RSU agreement should say if and when double-trigger RSUs that have not yet become fully vested will expire.
What is the RSU code in Box 14 of my W-2?
"Other" income is listed in Box 14 of your W-2. Box 14 doesn't have a standard list of codes, so employers can choose how to explain the income here. If you see "RSU" followed by a dollar amount, it probably means that your employer gave you restricted stock units (RSUs) worth that amount of money during the tax year.
Are RSUs taxed twice?
You may have to pay two different kinds of taxes on RSUs, but you won't have to pay taxes twice on RSUs. When the shares become yours, they are taxed at the same rate as your regular income. If you keep them, you may have to pay capital gains tax when you sell them and make a profit. Once on the fair market value at the time of vesting and once on any gain, but not twice on the same amount.
RSUs are a way for early-stage companies that may not yet be able to pay competitive salaries to lure talent away from bigger companies. At the same time, RSUs offer employees who are willing to take risks and work for a startup a unique and potentially lucrative benefit.
Some companies give RSUs, while others give stock options. Also, some companies only give these kinds of pay to a small number of their employees. In the end, RSUs and stock options are extra forms of pay, like your paycheck, 401(k) match, and health insurance plan, and you should think about them when deciding whether or not to take a job offer.
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I hope this information was helpful. If you have any questions, feel free to reach out. I’d be happy to chat with you.
About the Author
As Managing Partner of Vincere Wealth, Josh assists clients in navigating financial challenges and making sound financial decisions. Having someone guide you in making sensible financial decisions today can have a substantial impact on your future financial wellbeing. Josh takes great pride in guiding customers through the complexities of taxes, real estate, businesses, employer stock, and international financial planning.
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