Some people think that owning regular stocks is similar to owning Restricted stock units or RSUs. Irrespective of the menacing name, RSUs could be a valuable tool for planning. Big companies such as Google and Tesla provide their employees with RSUs to retain talented employees and keep them engaged in the company. RSUs value depends on the market value of the company’s shares, and this encourages employees to work harder. By granting employees RSUs, the employer provides a non-monetary incentive to staff that can materialize into a large reward in the end.
Restricted Stock Units or RSU
RSU is not a stock option, and neither is it a stock. It is a type of compensation that companies give to their employees. It is in the form of an unvested stock that is later vested at a specific date, acting as a compensation to the employee in the future.
What are Restricted Stock Units or RSUs?
A Restricted Stock Unit is a form of company shares that the employer gives the employee as compensation. You must be thinking about how to sell a RSU? Well, RSUs are only provided to employees when they stay with the company for a certain period of time or based on their performance milestones acquired. This is presented with a vesting period.
Even though an RSU presents the employee with interest in the company, it is of no worth until the vesting period is complete. When they are vested, these restricted stocks are presented with a fair market value. Additionally, it is termed as income; thus, a part of it is reserved for paying taxes on income. The remainder of the RSUs is with the employee, and he can sell them when he wants.
Advantages of RSUs
RSU as a whole is an advantage to the employees since they receive it as a reward for their work and their loyalty to the company. If the employees continue to perform exceptionally well and assist the company in the long term, the share price can increase. The employee has two choices, either they can choose to hold the stock after it is vested in hopes for a higher profit margin, or they can sell it the moment it is vested for better returns.
The amount the employee will receive will be the proceeds from the sale of shares minus the withheld shares (taxes are charged on RSUs, in order to pay for them a part of the proceeds or the shares is withheld) minus the due amount in capital gains taxes. The remainder of the profit goes to the employee. Since the employers do not have to track the shares’ records, the administration costs are close to zero. RSUs further enable the company to delay issuing shares until the vesting date arrives. Delaying the issuance of additional shares prevents the dilution of shares.
Limitations of RSUs
Actual shares are not allocated as RSUs as they do not provide dividends. Though to help offset the taxes, the employer can pay the amount equivalent to the dividends in an escrow account. This amount can also be used to buy more shares. Section 1244 of the Internal Revenue Code governs RSU taxation.
Restricted stocks are recognized on the vesting date and for tax purposes, are included in the gross income. Since the IRS does not consider RSUs to be a tangible asset, they are not eligible for the IRC 83(b) Election. This means that the employee holding the RSU does not have to pay the taxes on RSUs before the vesting period is complete. Until the actual shares are issued, RSUs do not provide the employee with voting rights.
In case the employee decides to leave the company before the vesting date, they will automatically forfeit the remainder of his shares. For example, Bonnie is an employee who resigned after 2.5 years after acquiring her RSUs. She holds 10,000 RSUs with a vesting period of five years. When she resigns, she will forfeit the 5,000 RSUs.
Selling Restricted Stock Units or RSUs
Selling RSUs is not the same as selling regular stocks. You need to decide if you want to hold or sell the RSUs and the right time to sell them. For this, you need an RSU selling strategy.
When should I sell my RSUs?
An employee gets into a dilemma when deciding to sell or keep the shares and how to sell the RSU. If you decide to sell the RSUs, you need to decide when will be the right time to do so. It is common to sell the vested RSUs as soon as one receives them. Then you should add the acquired proceeds to your investment portfolio to make it well-diversified. But there are a few exceptions to this. Here we will look at both of the scenarios.
To help attract and retain experienced employees, the company seeks to align the shareholders and their interests by providing RSUs in equity compensation. On top of regular salary, this additional income can represent the total remuneration of an employee. From an employee’s viewpoint, once the RSUs have vested and shares are received, they sell it for cash. The RSU served its purpose of being a compensation tool. This extra compensation, when received, is taxed as income. The incentive is received as shares, not cash, and is not relevant to companies that are common with publicly traded shares.
It becomes an investment decision at the point of acquiring the RSUs. You have to choose to keep the stock or sell them. In order to make this choice, you will have to evaluate the RSU stock as an investment. Analyze how RSUs fit in your existing portfolio if the portfolio is built on a well-analyzed asset allocation that uses diversified investments, such as mutual funds. In this case, selling them for cash will defeat your portfolio’s whole purpose, as it is based on diversification and development.
Should I sell my RSUs immediately after vesting?
RSUs are restricted because they are subject to a vesting period. When the RSU is vested, actual shares are awarded to the employee. In a majority of cases, the RSU selling strategy is to sell the RSUs immediately after the vesting period. However, there are exceptional cases where this may not be the go-to strategy. The company’s future and your ability to bear the financial risk might make a case against selling the stock after the RSU vests.
Owning a company’s shares while being an employee poses a double risk, as there might be a decrease in the asset’s value resulting in income loss. Having the capability to recover from the loss, especially if the RSU vesting is a small fraction of your assets, is acceptable. If you are someone who can bear the financial burden of potential loss and see the company growing, you should hold on to the stock.
Consider RSU taxation when sold
RSU taxation is something to consider when you are deciding whether or not to sell. They are taxable when it is delivered after they are vested. It is taxed on the value of the shares in the market at the time it is vested. The RSU taxation includes state and local taxes, federal income taxes, medical, social security taxes, and others.
The vested RSUs will be presented as income during taxation. RSU income requires compulsory withholding, and your employer might offer some options to cover the cost. It might also be required that only one method is used to pay the withholding. You might also be able to pay this cost with money from your pocket, not requiring you to sell your shares. The other RSU selling strategy is to sell part of your shares to cover the cost. The company may also offer you an option to surrender your RSU vesting or the shares back to cover the withholding tax.
In 2020, income withholding tax was 22%, with other withholdings made for other taxes. The company will hold on to some of the shares that amount to the total tax liability. As shares of the company, the after-tax value of the shares vested is deposited into a brokerage account. There are different types of tax implications for different scenarios. When the business gives you the RSU grant, there is no tax as it is not vested. Once you vest the RSUs you will have to pay ordinary income tax on the share value, as it is considered as income.
Once the tax is paid after the RSU vests, the shares are now yours. One thing to keep in mind is that if there are capital gains due to increased share prices, you might owe more tax. This will only be in the case of additional gain. If you hold the shares for a year or more, you will have to pay a long-term capital gains tax. If you hold it for less than a year, you may pay a short-term capital gains tax.
Investors might choose to hold on to the shares for more than a year before selling them, allowing them to take advantage of the long-term capital gain rate. Or in other cases, they choose to sell them after the RSU vesting is complete to pursue goals. This does not require any additional taxes since there is no time for the price of the stock to change.
|Receiving RSUs||No tax liability|
|Once RSU is vested||Pay income tax on the shares|
|If you sell them within a year of vesting||If the price the share is sold at is higher than the fair market value, you will have to pay short-term capital gains tax on the difference.|
|If the employee waits more than a year to sell the shares after the vesting date||Depending on the price, if it is higher than the fair value then you will pay long-term capital gains on the difference in the amount.|
Employees are often in the dilemma of how to sell RSUs with trade restrictions. When you receive an RSU, the restrictions put on them may prevent you from selling them immediately. There are some companies that put a trading window on RSUs. This means that there is a certain period of time in which you will be permitted to sell your shares. Before selling your shares, you will have to wait for the trading period to commence. This period can be several days or even weeks.
- Milestone based restrictions: There are RSUs that are based on milestones. The RSU can only be vested if the employee reaches the milestone. For example, a salesperson can vest his RSUs by achieving a milestone of selling 20 houses in one year.
- Time-based restrictions: The most common restricted shares are time-based. This type of incentive is provided to an employee for their loyalty to the company. The time-based RSUs will encourage the employee to stay loyal and retain his position till the vesting period.
- Time and milestone-based: In certain cases, the company gives an RSU both a time-based and milestone-based restriction. To attain the shares, the employee has to be loyal to the company and achieve a milestone.
Other companies use the IPO as the trigger for RSU vesting. Here you might be constricted by a lock-up period. A lock-up period is a set time through which you are not authorized to sell your share, and they are usually about 90 to 180 days.
RSU life-cycle example
In this example, we will highlight the full life-cycle of an RSU grant. As an employee in Starbeast Inc, you received a 12,000 RSU grant. This is to be vested at the rate of 25% a year, and the FMV for the grant is $36. When vested after one year, the stock price is $40 ( 2000 x $40 = $80,000 of the ordinary income).
In the second year, $50 ($100,000), in the third year, $60 ($120,000), and in the fourth year, $66 ($132,000). The total of all four years is $432,000. Each increment is subject to tax on the vesting date as compensation income when the shares are delivered.
You can choose to sell the RSUs two years beyond the vesting date at $100 ($800,000 for the 8,000 shares). The capital gain would then be $800,000 – $432,000 = $368,000. This is reported on the employees’ tax return form 8949 and schedule D. If the employee chooses to hold on to them for an additional year after the share delivery, the proceeds from the sale of the shares will be taxed as long-term capital gains.
Looking to sell RSUs in your company?
RSU is the most controlled and direct type of compensation given to the employees. Usually, it is recommended to sell the RSU immediately after the vesting period is complete to avoid any additional taxes. Insiders and employees that hold the RSU, need a RSU selling strategy. But for investors with a different and more diverse portfolio, holding on to the RSU is the choice to make. Tools will help make it easier to track the company’s shares price, presenting you with a summary of all types of shares issued in the company. Eqvista is a platform that provides you with the necessary tools to make it an easier process to do financial analysis, cap table management, keep track of issuance of company shares, and so much more.