Planning for RSUs
By Laura Johnson, EA
Restricted stock units, or RSUs, are a popular source of equity compensation used by companies to reward employees and retain talent. It works like this. A company, on grant, promises to give an employee shares at a later date subject to time or performance metrics. As a basic example, Company A grants John 100 shares, subject to a two-year vesting period. If John is still working at the company two years after the award date, he will receive 100 shares of Company A stock. Real shares which he can do as he pleases with. If John leaves Company A before the two years are up, he will receive nothing.
What does this mean for taxes? The taxable event for RSUs comes when the shares vest, not at the award date. The value of the shares is compensation. Very often some of the shares are sold by the company to cover taxes and the company issues the net shares to the employee. This is known as a sell-to-cover transaction.
Many employees incorrectly assume that the withholding at source will be enough to cover the corresponding tax bill. It very likely won’t be. Why? RSUs are considered bonus compensation and subject to special bonus withholding rates for supplemental wages. Awards under $1 million are withheld at a flat 22%. Awards over $1 million are withheld at 37%. In our experience, most employees who receive RSUs are taxpayers whose marginal tax rates are higher than 22%. That means by default you are going to owe more tax. Example, John receives $100,000 of RSUs, subject to the 22% withholding rate described above. His highest marginal tax rate is 32%. He will be short by 10% or $10,000. Be sure to budget appropriately at tax time.
Now you have shares of stock in the company. What do you do with them? You could hold onto them, hoping for the stock to increase in value. Long-term capital gains rates will apply on appreciation between the vesting date and the sale date, AFTER you have held the shares for a year (from the vest date, not the award date). This strategy could make sense if you thought the prospects of the company were bright. Or you could sell them and take the cash.
Holding the shares is not without risk, perhaps substantial tax risk. Suppose John received stock worth $100,000 on June 1st. We know that $22,000 would have been withheld for federal tax and that John, given his marginal tax rate should expect to pay an additional $10,000 the following April. But what if the company's stock price declines between June and the following April or worse, completely crashes? John would be left paying real tax on $100,000 of income, on an asset whose value has evaporated. Not ideal.
Taxpayers who receive RSUs would be wise to consult with an investment advisor to ensure vested RSUs shares fit within the scope of your portfolio and risk tolerance. If you do not work with a financial advisor, one simple strategy to avoid tax risk is to sell all the RSUs as they vest and take the cash. This strategy ensures that you receive the full value of the compensation that you are required to pay tax on.
At JS+A we help clients plan for tax events associated with RSUs and other forms of equity compensation. Please let us know if we can help you today.
