RSU Taxation: Everything You Need to Know

Since paying employees is a significant expense for most businesses, many companies pay some of the remuneration using shares. The laws and regulations governing several forms of stock compensation are distinct. Employees’ total pay packages sometimes include restricted stock units, a type of equity remuneration.

The United States has its own set of regulations regarding RSU taxation, and several variables can affect when and how much tax is due. This article covers all the information you need regarding the RSUs tax considerations, avoiding double taxation and the most important tax planning strategies to keep you informed.

RSU taxation

Employees, especially those in the technology sector, often get Restricted Stock Units as a form of remuneration. In certain instances, such as for Amazon employees, RSU compensation might be over 50% of their yearly salary.

What are RSUs?

Restricted stock units go to employees as remuneration by their employer, who may give them one or more of the company’s stocks. If the recipient wants to sell the shares before the vesting term ends, they can do so anytime.

RSUs are not sellable until the end of the vesting period, which has a set duration. It is common practice for companies to keep such stocks so that employees can immediately profit upon meeting specific criteria.

For instance, when an employee reaches certain performance goals, the vesting period might end. It is also possible for a vesting period to finish after an employee has worked for a certain company for a set amount of time. In contrast to regular restricted shareholders, RSU participants cannot vote on the stock throughout the vesting period, as no stock has been granted.

Why do companies issue RSUs to employees?

Some of the reasons why restricted stock units are a good investment are as follows:

• Promotes employee retention by rewarding their dedication to the company over an extended length of time.
• Encourages them and motivates them to provide their ultimate effort.
• Investors patiently waiting for allocations can profit from the capital gain, less any income tax deductions. This just requires that the company’s stock value has grown.
• Because they are not actual stocks, businesses may save a ton of money by not having to keep track of them.

Example of RSU Taxation

Alex, an engineer of Zark Inc., has been granted Restricted Stock Units as part of his compensation package. In this simplified example, we’ll explore the basic taxation of for Alex, covering the grant, vesting, and eventual sale of the shares

• Grant Date (Year 1): Alex is granted 500 RSUs with no immediate tax consequence.
• Vesting (Year 2-3): 250 RSUs vest each year.
• Fair market value at vesting:
  • Year 2: $50 per share
  • Year 3: $60 per share
  • Year 2: 250 RSUs vest and Alex’s taxable income is 250 * $50 = $12,500.
  • Year 3: Another 250 RSUs vest, and Alex’s taxable income is 250 * $60 = $15,000.
• Selling the Shares (Year 3+):
  • Suppose Alex sells all 500 shares in Year 3 at the current market price of $65 per share.
  • Capital Gain = (Selling Price – Fair Market Value at Last Vesting) * Number of Shares Sold
  • Capital Gain= ($65 – $60) * 500 = $2,500

Any gains or losses resulting from the sale will be subject to capital gains tax. If Alex sells the shares at a price different from their market value on the vesting date, he will realize either a capital gain or loss, subject to capital gains tax.

Basic mechanics of RSU Taxation: Vesting, grant date and the value

The following definitions should make RSUs easier to understand than other forms of equity compensation:

• Grant Date – Your employer commits to providing you with a certain amount of “restricted” shares on the grant date. Earning these shares is subject to a vesting term, which may be months or years long or linked to particular performance goals.
• Vesting Schedule – The day the shares are “vesting,” or officially yours (i.e., no longer “restricted”), is important. In a normal vesting schedule, 25% of the shares are due annually for four years.
• Value – Employees incur no direct costs (other than taxes) when purchasing RSUs but take on market risk. Employees incur capital losses if the value of their shares decreases upon vesting.

What are the tax considerations on RSU Taxation ?

Tax considerations of RSU are crucial for employees and companies. Income from the same is subject to ordinary income tax at the time of share vesting, with the amount taxed depending on the value of your shares on that day.

You must be aware of the distinctions in the tax consequences of RSUs and other types of equity compensation, including stock options, to make an informed comparison.

Deferring taxation on stock options is common practice until the first of two events occurs: the sale of the shares or exercising the options. However, ordinary income taxes may be triggered upon execution of non-qualified stock options (NSOs), and alternative minimum tax (AMT) requirements may result from executing incentive stock options (ISOs).

There is a big difference in when and how taxation is applied between RSUs and stock options, even though both provide equity compensation. Unlike stock options, which might have tax consequences at exercise and sale, RSUs have a simple taxation mechanism where taxes are required at vesting. Employees must have a thorough understanding of these differences in order to navigate their equity pay packages effectively.

RSU Taxation: Vesting and Tax Implications

Unlike traditional restricted stock programs, RSUs are subject to less complicated taxes. It is not possible to make a Section 83(b) election where there are no real shares issued at grant. Because of this, the declaration of stock value is possible once during the plan’s lifetime.

Assuming the grant occurs on the same day as vesting, the reported amount will equal the stock’s fair market value. Consequently, the ordinary income for the year in which the stock gains vested status is the worth of the stock.

Taxation upon vesting: What happens when RSUs become yours

Upon vesting, RSUs are deemed taxable income since they are compensation. A withholding rate of 22% to 37% may apply to income due to its classification as supplementary. In most cases, your employer will sell off a portion of your shares to satisfy the withholding mandate. You would have to pay taxation at the federal, state, and municipal levels.

Once your RSUs have vested, they will be regarded similarly to regular stock shares. The market value of the shares at the time of vesting will serve as your tax basis, equal to the earlier amount subject to income tax. Your tax return will reflect the gain (or loss) from the sale of the shares as capital gain.

After the vesting date, you must hold on to the shares for a year to get the long-term capital gains allocation (up to a maximum of 20%). Without this, you can only deduct the gain from your ordinary income in the year of sale, and it will not be longer-term.

You can better prepare for the tax consequences if you know when they vest. There are several financial tactics you may employ to lessen the effects, including selling shares to pay the bill.

• Before filing their taxes, employees should calculate their expected RSU taxation burden based on each vesting event.
• When determining whether to sell or hold the vested shares, employees might consider the state of the market by keeping an eye on vesting dates.
• A vesting date is a good time to diversify your investments.
• Selling a portion of your shares upon vesting might assist in mitigating concentration risk if a significant portion of your wealth has a connection to company stock.

RSU Taxation at Grant Date

There is usually no immediate taxation on RSUs on the issuance date. Gains are not taxable to workers until the units become fully vested. It is critical to consider the FMV of the company’s shares as of the grant date. The amount of taxation distributed to workers depends on this figure.

Although the fair market value (FMV) as of the grant date has no bearing on present taxes, it does become relevant when vesting occurs. The employee’s taxable income is the variance between the fair market value (FMV) at award and vesting.

RSU Sale and Capital Gains

The stock is subject to capital gains tax regulations upon sale following vesting. A capital loss or gain is the effective tax treatment of the disparity between the selling price and the stock’s cost basis. The cost basis of the shares is the stock’s fair market value (FMV) on the vesting date, plus any dividends or additions that have been reinvested.

• The phrase “long-term” applies to any gain or loss in capital after the vesting date but before the first year of holding the shares.
• Short-term capital gains or losses apply to shares held for a year or less.

Let’s say an employee held off selling their stock in the firm for a week. The stock value now is $6. The worker will obtain a short-term financial gain of $2,500 if they sell the 2,500 shares vested last week. With an employee in the 35% tax rate, the resulting capital gains RSU taxation would amount to around $875.

The employee would benefit from a favorable capital gains tax bracket of 15% or 20% if they held the company’s stock for a year before selling the shares. With a one-year and one-week holding period and a share price of $6, the employee would realize a long-term capital gain of $2,500. About $500 would go toward capital gains tax if the worker is liable for the 20% long-term rate.

RSU Tax Planning Strategies

Understanding RSU taxation can be challenging; the best approach will rely on your unique situation. Using the following strategies, you can lessen your total tax burden and better understand the complexities of taxation.

• Maximizing Tax Efficiency – Plan the timing of vesting and sales to optimize your tax efficiency. This may involve coordinating with other income sources and considering your tax bracket.
• Utilizing Tax-Advantaged Accounts – Consider transferring vested RSUs to tax-advantaged accounts like Individual Retirement Accounts (IRAs) or 401(k)s if permitted. This can potentially defer taxes until withdrawals and provide additional tax benefits.
• Tax-Loss Harvesting – Actively manage your investment portfolio to take advantage of tax-loss harvesting opportunities. Offsetting gains with losses can minimize your overall tax liability.
• Consulting with Tax Professionals – Seek advice from tax professionals or financial advisors specializing in equity compensation. They can provide personalized guidance based on your financial situation, goals, and applicable tax laws.
• Understanding AMT – If you’re subject to the Alternative Minimum Tax (AMT), factor this into your taxation planning. Strategies like timing the sale and managing other AMT preferences can be explored.

How to avoid double taxation on RSUs?

Selling RSUs could result in double taxation if you do not submit your taxes appropriately. It comes down to accurately reporting equity pay and using the cost basis for equities. Duplicate taxation payments are possible due to inaccurate reporting of cost basis or failure to account for previously paid regular income taxes.

There are several measures you may take to guarantee the accuracy of your tax return and prevent the possibility of double taxation.

• Track Down Additional Tax Records – Substitute other forms for the 1099-B. If you want to pay taxes just on what you owe, you should prove the restricted stock unit’s genuine cost basis instead. The following may be included in some documentation:
  • Documentation from your employer attesting to the quantity and date of shares vesting
  • Additional information on the 1099-B that specifies the cost basis
  • Form W-2
• Verify Sales Accurately – The sale of RSUs results in taxable income. When you sell your stocks for more than their cost basis, which you have already paid taxes on, the difference is your income. Pay the right capital gains tax rate by accurately reporting the sales.

Try Eqvista Now for Seamless Stock Management

RSUs can potentially constitute a significant chunk of your overall remuneration. When incorporating them into your long-term financial strategy, their taxes are just one of many factors to think about.

Working with a tax expert is essential to appropriately include your long-term incentives, like your RSU, into your overall financial strategy. With Eqvista, a powerful cap table management software, founders may perform many things, including managing stocks, issuing ESOPs and RSUs, and setting vesting schedules. Take a look at the app and give it a go right now!