What are restricted stock units (RSUs)?

Equity compensation and stock-based rewards, such as restricted stock units (RSUs), have become increasingly common in today’s job market. However, if you’re new to the concept, it’s easy to get lost in the jargon and miss out on the potential benefits.

If RSUs are included in your compensation package, you’ll need to understand what they are, how they work and how they’re taxed, so you can make informed decisions about your financial future and career path.

Let’s start with a quick review of the basics of RSUs.

Understanding RSUs

RSUs are a form of equity compensation granted by an employer to an employee in the form of company shares. These shares are “restricted” because they are subject to a vesting schedule, which means you must meet certain conditions — such as remaining with the company for a specified period or achieving performance milestones — before you can fully own the shares. 

Once the RSUs vest, the employee receives the shares without having to pay for them.

RSU vs. stock options

People often confuse RSUs with stock options because both are forms of equity compensation, but they have distinct differences. To clearly define stock options vs RSUs-

• RSUs are shares that are given to you (after they vest). You do not have to pay for them, because they are part of your compensation package.
• Stock options give you the right to buy a certain number of company shares at a specific price (called the strike price) within a certain time frame.

Learn more in our free e-book, Equity Compensation Tax Strategies: Quick Start Guide.

Understanding your RSU vesting schedule

You’ll need to understand the vesting schedule of your RSUs and plan accordingly so you’ll be able to meet your near-term and long-term cash flow needs and savings goals.

Typically, vesting schedules span several years, with a portion of your shares vesting each year until you’ve earned the total amount granted to you.

If you decide to leave the company before your RSUs fully vest, you’ll forfeit any unvested shares. This means you’ll miss out on not only the income those shares would have provided but also any potential future appreciation in the stock’s value. 

When you’re making decisions about your career and financial planning, factor in your vesting schedule so you can maximize your RSU compensation while also considering your personal and professional goals.

How are RSUs taxed?

RSUs have varying tax implications compared to a traditional all-cash salary, making them more complex to navigate.

When RSUs vest, the fair market value of the shares at vesting is considered ordinary income. This income is subject to federal income tax, Social Security and Medicare taxes, as well as any state and local taxes. The company usually withholds some shares to cover these taxes.

For example, let’s say you’re granted 2,000 RSUs that vest after 3 years. When they vest, the stock price is $100 per share. The total value of $200,000 (2,000 shares x $100) is considered ordinary income. If your total tax rate is 35%, about 700 shares (worth $70,000) might be withheld for taxes, leaving you with 1,300 shares in your brokerage account. The full $200,000 will be reported on your W-2.

After vesting, if the employee chooses to sell the shares, the difference between the sale price and the fair market value at vesting is treated as a capital gain or loss. The tax treatment depends on how long the shares were held after vesting:

• If the shares are sold within one year of vesting, the gain is considered a short-term capital gain and is taxed at the ordinary income tax rate.
• If the shares are sold more than one year after vesting, the gain is considered a long-term capital gain and is taxed at the more favorable long-term capital gains rate.

Back to our example, if you sell the remaining 1,300 shares immediately, there’s no additional tax. However, if you hold them for 8 months and the price rises to $120, selling would result in a short-term capital gain of $26,000 ((1,300 shares x $120) – (1,300 shares x $100)).

If the value of the shares decreases between vesting and sale, the loss can be used to offset other capital gains, and in some cases, ordinary income.

Staying on top of RSU withholding

When RSUs vest, it’s crucial to ensure that you are withholding enough to cover the taxes owed. Your company will generally withhold up to the statutory rate of 22% for federal taxes, but depending on your tax bracket, this may not be sufficient.

For example, let’s say you are in the 37% tax bracket and have $100,000 worth of RSUs vesting. If your company only withholds 22% for taxes, you’ll be short by 15%. To cover this gap, you’ll need to take additional steps to make sure you’re not hit with an unexpected tax bill on April 15th.

One option is to withhold more from your payroll, but this can be challenging to coordinate with your employer. A more practical approach is to work with your CPA or tax planner to make estimated quarterly tax payments. By proactively paying a portion of your estimated tax liability each quarter, you can avoid a significant tax burden at the end of the year.

Remember, failing to withhold enough taxes can result in penalties and interest charges, so it’s crucial to plan ahead to meet your tax obligations. You’ll have a far smoother tax season (and avoid unwelcome surprises) when you understand withholding rates and take proactive steps to cover any shortfalls.

RSUs and beyond: Strategies for reducing taxes from equity compensation

Understanding how RSUs work, how they’re taxed and how they fit into your overall financial plan is essential for making the most of this valuable form of equity compensation. The good news is that there are ways of decreasing the taxes you pay on equity compensation.

To learn more about reducing taxes and building wealth with your equity compensation, download our free e-book, Equity Compensation Tax Strategies: Quick Start Guide.

 This comprehensive guide will provide you with valuable insights and strategies to help you maximize the benefits of your RSUs and other stock-based rewards.

If you need additional support, the trusted advisors at KFA Private Wealth Group can help you make informed decisions about your equity compensation package. Learn more about our approach to equity compensation and talk to us to find out how we can work with you to create a personalized plan that aligns with your financial goals.