RSUs (Restricted Stock Units) – Everything You Need to Know

As a tech professional, you may be familiar with Restricted Stock Units (RSUs) as a form of equity compensation offered by many companies in the industry. RSUs are an attractive benefit that can significantly contribute to your overall income and net worth. However, understanding how RSUs work, their tax implications, and incorporating them into your financial plan can be complex. This comprehensive guide will walk you through everything you need to know about RSUs, empowering you to make informed decisions and maximize the value of your compensation.

What are Restricted Stock Units (RSUs)?

RSUs are a type of equity compensation where your employer grants you shares of the company’s stock, to be received at a future date and subject to certain conditions. These conditions are usually time-based, with shares “vesting” over a period of three to four years. Some companies include an event-based condition as well. Unlike stock options, which give employees the opportunity to purchase company stock at a predetermined price, RSUs are typically granted at no cost to the employee. Once they vest, they’re yours.

How do RSUs work?

To fully understand how RSUs work, it’s essential to grasp the concept of vesting. When you receive an RSU grant, it comes with specific vesting conditions outlined in your RSU agreement. These conditions can be time-based, milestone-based, or a combination of both. Time-based vesting requires you to remain employed with the company for a certain period before the RSUs fully vest. Milestone-based vesting may be tied to events such as an Initial Public Offering (IPO), a company acquisition, or the completion of performance milestones or projects.

Upon meeting the required conditions, the RSUs vest, at which point the stock becomes your direct property. It’s important to note that until the RSUs vest, you do not have ownership of the shares or the ability to sell them.

Single-Trigger RSUs vs. Double-Trigger RSUs

RSUs can be categorized as single-trigger or double-trigger based on the vesting conditions. Single-trigger RSUs vest based on either time or milestones, while double-trigger RSUs require a combination of both. In most cases, RSUs issued by privately held companies are double-trigger RSUs, and most-often the second trigger is an IPO.

How are RSUs taxed?

Understanding the tax implications of RSUs is crucial for maximizing their value. While the exact tax treatment may vary based on your individual circumstances and the country you reside in, the following provides a general overview of the common tax considerations for RSUs.

Ordinary Income Tax on Vesting

When your RSUs vest, you are required to pay ordinary income tax on the fair market value (FMV) of the underlying shares at that time. This means that the value of the vested RSUs will be added to your taxable income for the year, and you will owe taxes based on your income tax bracket.

Here’s an example to illustrate:

• Bill receives a grant of 1,000 RSUs on 6/1/22, vesting annually over four years or 25% per year.
• In June of 2023, 250 of Bill’s share vest and the stock price is $50 per share
  • This equates to (50 x 250) or $12,500 of income
• At Bill’s tax rate of 35%, his income tax bill on these vesting shares is $4,375

Now, it’s really important to note that if you make less than $1mm, your company will only withhold 22% by default for federal taxes, which means that in many scenarios the default withholding may not be sufficient, and you may want to set aside extra cash for this tax bill. We built an RSU Tax Withholding Calculator as a way for you to get a sense for whether you might fall under this scenario.

Capital Gains Tax on Sale

If you sell your RSUs the date that they vest, then you don’t have to worry about capital gains. However, if you hold them and decide to sell them at a later date, any appreciation in value will be subject to capital gains tax. The capital gains tax rate depends on your holding period. If you sell the shares within one year of receiving them, the gains will generally be considered short-term and taxed at your ordinary income tax rate. However, if you hold the shares for more than one year before selling, the gains will be considered long-term and taxed at the applicable long-term capital gains tax rate, which is typically lower than the ordinary income tax rate.

Here’s an example to illustrate:

• In June of 2023, 250 of Bill’s shares vested with the stock at $50 per share. This means that his cost basis was $12,500.
• In December of 2023, Bill decides to sell 100 of his shares at $100, generating a taxable gain of $5,000.
  • Since these shares were held for less than a year, they’re taxed at his income tax rate of 35%, generating a tax bill of $1,750.
• Bill decides to sell the remaining 150 shares in July 0f 2023 at $200, generating a taxable gain of $22,500.
  • Since these shares were held for more than a year, they’re taxed at the long-term rate of 15%, generating a tax bill of $3,375.

How can I reduce tax on RSUs?

Minimizing the tax impact of RSUs requires careful planning and consideration of various strategies. While it’s important to consult with a financial or tax advisor to tailor a plan that aligns with your specific circumstances, the following strategies may help reduce the tax burden on your RSUs.

Exchange Funds

An exchange fund is a financial vehicle that allows investors to swap their appreciated assets (such as RSUs) for a diversified basket of other assets, typically stocks, held within the fund. Any capital gains on the swapped assets are deferred until the end of the life of the fund (typically seven years), at which point the diversified basket of stocks is distributed out for you to sell or hold as you see fit.

Trust Strategies

There are certain types of trusts that can be utilized to defer taxes of appreciated assets. One option (though not the only one) is a charitable remainder trust, or CRT. A CRT is a financial arrangement where an individual or entity transfers assets, such as RSUs, into a trust, and in return, they or their designated beneficiaries receive regular income payments from the trust for a specified period or for life. Upon the trust’s termination, the remaining assets are donated to a charitable organization. There are two key benefits with this strategy. One is that the donor receives a large tax write-off upfront, and the second is that the assets are allowed to compound on a tax-deferred basis.

Tax Loss Harvesting

Coordinating your RSU strategy with other investments in your portfolio can help optimize your overall tax situation. As part of the enhanced direct indexing strategy we utilize at Proventus, we systematically harvest tax losses from existing positions which can then be used to offset RSU capital gains. 

Maximize Retirement Contributions

Contributing to retirement accounts, such as a 401(k) or Individual Retirement Account (IRA), can help lower your taxable income. By maximizing your contributions, you effectively reduce the amount of income subject to ordinary income tax, including the value of your vested RSUs. Additionally, some retirement accounts offer tax-deferred growth, allowing you to potentially defer capital gains taxes until you withdraw the funds in retirement.

Utilize Stock Compensation Strategies

Certain stock compensation strategies can help manage the tax impact of RSUs. One approach is to sell a portion of the vested RSU shares immediately upon vesting to cover the tax liability. This strategy is known as “sell to cover” and allows you to satisfy the tax obligation without using your own funds. Another strategy is to hold onto the RSU shares and consider a tax-efficient selling plan that spreads out the sales over multiple years to minimize the impact of capital gains taxes.

Gift or Transfer RSU Shares

Transferring or gifting RSU shares to family members or charitable organizations can be a tax-efficient strategy. By transferring the shares, you may be able to utilize their lower tax brackets or deduct the value of the donated shares from your taxable income. It’s essential to consult with a tax professional to navigate the specific rules and regulations regarding gifting or transferring securities.

What should I do with my RSUs?

Deciding what to do with your RSUs depends on your financial goals, risk tolerance, and overall investment strategy. Here are some considerations to guide your decision-making process:

Diversify Your Holdings

While RSUs can be an attractive form of compensation, it’s generally advisable to diversify your holdings over time. Holding a significant portion of your wealth in a single stock, such as your employer’s, can expose you to concentrated risk. By selling some or all of your vested RSU shares and reinvesting the proceeds in a diversified portfolio, you can potentially reduce risk and increase your long-term financial stability.

Incorporate RSUs into Your Financial Plan

Integrating RSUs into your comprehensive financial plan is crucial for maximizing their value and aligning them with your overall goals. A financial advisor can help you evaluate the impact of RSUs on your financial picture, develop a tax-efficient strategy, and ensure that your investment decisions align with your risk tolerance and long-term objectives.

Consider Your Time Horizon

Your time horizon, or the length of time until you need the funds from your RSU shares, should also inform your decision-making. If you have a short-term financial goal, such as purchasing a home or funding education expenses, it may be prudent to sell some or all of your RSU shares to access the funds. On the other hand, if you have a longer time horizon, holding onto the shares and potentially benefiting from further appreciation may be a viable strategy.

Main Things to Watch Out For

Wash Sales

One thing that tends to be very overlooked when it comes to RSUs is wash sales. In a nutshell, The wash sale rules in the U.S. tax code disallow taking a tax loss relating to a sale of stock if, within a period beginning 30 days before or ending 30 days after the sale, you acquire substantially identical stock.

Why does this matter for RSUs? Well, the answer is that vesting RSUs are viewed by the IRS as a purchase. This means that you cannot recognize a loss on your RSUs if you are within 30 days before or after a slug of RSUs vesting. This creates some very tricky timing, and we’ve seen scenarios in the past where an employee sold RSUs to recognize a significant tax loss, just to realize a few months later than their loss was not allowed by the IRS. 

Withholding shortfalls

We mentioned this earlier in the article, but it bears repeating. Generally, your company will only withhold at the supplemental rate of 22% if you earn below $1mm. This frequently leads to situations where the shares withheld for taxes on vesting RSUs aren’t sufficient to cover the full tax bill, and an employee will get hit with a surprise tax liability at the end of the year. It’s important to track this carefully and ensure that either you’re selling additional shares to cover the tax bill, or you are setting aside cash for any extra tax. Speak with your financial advisor to make sure you have a solid plan in place.

Conclusion

RSUs are a valuable form of compensation for tech professionals, but navigating their intricacies and maximizing their value requires careful planning and consideration. By understanding how RSUs work, the tax implications, and incorporating them into your financial plan, you can make informed decisions that align with your goals and optimize your compensation.

At Proventus Wealth, we specialize in helping tech professionals manage their RSUs – everything from strategizing around the timing of sales, to reinvesting the proceeds in a diversified portfolio, to making sure you’re not triggering wash sales. Get in touch with us to set up the right strategy so that you can make the most of your RSUs and set yourself up for long-term financial success.