Restricted stock units (RSUs) are an increasingly popular form of compensation. Although RSU tax treatment is fairly straightforward, this type of compensation can be understandably intimidating. In this post, we review what RSUs are, how they are taxed, and what you should do with them.
What are Restricted Stock Units (RSUs)?
Restricted Stock Units (RSUs) are a form of compensation income, very similar in tax treatment to wage income or a bonus. The main difference is the form of compensation: stock instead of cash.
Employers will grant RSUs to employees with certain restrictions. Upon meeting certain criteria (typically time-based but sometimes performance-based) the restrictions are lifted and the shares vest to the employee.
Through these RSU grants, your employer is (1) aligning your compensation with the performance of the company and (2) incentivizing you to remain at the company over the vesting period.
For example, your employer may grant you 1,000 shares of RSUs that vest over the next four years. Meaning on the anniversary of the grant date in each of the next four years, 250 shares will vest to you. If you leave your employer before any of these vesting dates, you will not receive the unvested shares.
Alternatively, your employer may grant you RSUs which will vest upon meeting certain criteria, such as a sales goal.
How are RSUs taxed?
RSUs have three key dates with differing tax implications.
1. Grant Date
The Grant Date is the date your employer grants you the RSUs. Because you do not have ownership or control of the shares at this point, there are no tax implications on the grant date.
2. Vesting Date
The Vesting Date is when the restrictions lift and the shares become yours.
On the vesting date, RSUs are taxable as ordinary income. The newly vested share amount will be subject to income and payroll taxes, like Federal, state, and FICA taxes.
For example, if 250 shares vest and your company stock is trading at $100 per share, then $25,000 (250 * $100) will be taxed as ordinary income. You are taxed on this $25,000 just like it was a cash bonus.
Most commonly, to cover these taxes your employer will sell-to-cover a portion of your vested shares. For example, if 250 shares vest, your employer may withhold 75 shares to cover taxes, leaving you with a net 175 shares.
3. Sale of Shares
Upon selling stock granted through RSUs, you will owe capital gains tax on the difference between the sale price of the stock and the price of the stock on the vesting date.
For example, if you hold your vested shares for a year and tstock's sale price and the stock's price to $120, you will owe capital gains taxes on the capital gain of $20 per share.
If you immediately sell your company stock, there will not be a capital gain and you don’t need to worry about this.
What should you do with your RSUs?
Probably sell them.
Why? Holding a significant amount of one company’s stock (even and especially your own company’s stock) will subject your financial future to an easily avoided risk.
Although it’s natural to fall into the thinking that (1) you know your company better than most, (2) you see an above-average future for your company, and therefore (3) you want to hold onto these shares, this would be putting far too many eggs in one basket.
Your financial future is already tied to the success of your company through your salary, bonuses, and prospects for raises and advancement. You may also be receiving more ayour company's success will vest in the future. It’s imprudent to further tie your family’s future to your company’s stock price.
As mentioned above, there is also no tax benefit to holding on and waiting to sell your shares. Once your RSUs vest, they are immediately taxed and treated as ordinary income.
Think of it this way: If you were given a cash bonus, would you take that cash and buy your company’s stock? By holding onto vested RSUs, that’s essentially what you are doing.
The example below compares two scenarios, receiving RSUs vs. a cash bonus, of an individual with an assumed 30% tax burden. The end result is the same.
What are the risks of holding onto vs. selling company stock?
Risks of Holding onto Company Stock
The risk of holding onto your company stock is similar to concentrating into any individual stock, with the added risk of having your employment prospects tied to this company too.
The story of GE is a noteworthy recent example of the risks of concentrating in your company’s stock. GE stock fell over 75% beginning in 2017 and in mid-2022 is nowhere near recovering these losses.
Compounding the share price losses, GE underwent downsizing during this period and its pension fund was among the worst-funded large corporate pension plans in the U.S.
As a GE employee, you are necessarily exposed to employment risks and pension funding risks of the company. There is little to nothing you can do about that. But you can mitigate added risk by not holding additional company shares.
Risks of Selling your Company Stock
Although you are reducing risk by selling your company stock exposure, there is one big "risk" you are taking: FOMO (fear of missing out).
By selling your company shares, you are exposed to the risk that your company’s stock price will skyrocket and you will watch coworkers who didn’t sell their stock become fabulously wealthy.
Of course, I would argue the benefits outweigh the risks here, but this can be a challenging emotional hurdle. Imagine working at Apple or Amazon, prudently diversifying your investments, but then watching these stocks trounce market returns over the last decade.
On the flipside, we have seen how massively successful companies, like GE, can experience dramatic stock losses. (And GE is far from the only example.)
If this is one of your hurdles in selling company stock, it's helpful to remind yourself that you are likely receiving additional RSUs that will vest in the future. So you still have some exposure to your company’s stock. And you will participate in that meteoric rise should your employer be the next Apple.
What if you already have a lot of vested shares?
If you already have vested shares that you have accumulated over the years, you may have significant gains in the positions and therefore be hesitant to sell them.
Although you have already been taxed on the value of the shares at the vesting date, any gains from that date will be taxed as capital gains.
The first step is to identify the value of your shares today. Next, identify your cost basis in the shares (the value of the shares on the vesting date). Your gain in the stock will be subject to capital gains taxes when you sell the shares.
Depending on how significant the gains are, you can determine a schedule for selling shares and reducing this concentration.
What’s important here is to avoid allowing the “tax tail to wag the dog.” Meaning: Don’t let tax consequences get in the way of reducing your concentration risk in your company stock.
And while you are working through your plan to sell your current shares, make sure you immediately sell additional shares as they vest to avoid adding to this concentration risk.
Tax-Planning Opportunities for RSUs
There is not much you can do regarding the income received from RSUs. You have no choice but to recognize the income according to the vesting schedule, just like your salary or a bonus.
But you can seek to maximize tax-advantaged savings opportunities in years when significant RSUs are expected to vest. This can reduce your taxable income and burden.
Common tax-advantaged accounts include traditional 401(k), IRA accounts, and Health Savings Accounts (HSAs). If you are charitably-inclined, you can make more significant gifts to charity in these years or use a donor-advised fund (DAF) to bunch the tax benefit of multiple years of giving into a single (high) tax year.
Contributions to these types of tax-advantaged accounts are deducted from your income before taxes are assessed. Investments in these accounts may also grow tax-free.
Your RSU Decision
Ultimately, you may choose to immediately sell your vested RSU shares or hold on in anticipation of above-average returns. Most importantly, understand how this concentration impacts your overall financial plan and asset allocation.
If you decide to hold onto your shares, create a plan for how large you will allow this position to grow, when you plan to sell shares, and how you will evaluate the performance of this stock compared to your opportunity cost (diversified investments).