Key Points
- Restricted stock units (RSUs) are a form of equity compensation that offer employees a promise of shares at a future date or upon meeting certain conditions.
- Upon vesting, RSUs are taxed as ordinary income based on the fair market value of the shares at that time, with the employer withholding taxes to cover the employee’s tax liability.
- Depending on the timing of the sale of the RSU shares, employees may also be subject to capital gains tax on any appreciation in the share price.
- RSUs can be subject to “double taxation” if they are taxed at the time of vesting and then again when the shares are sold, but there are strategies to minimize this impact, such as selling shares in a tax-efficient manner or holding onto the shares for at least a year.
- Employees who receive RSUs should carefully review the terms and conditions of their awards, as well as the tax implications of the awards, to fully understand the potential benefits and risks.
Introduction
If you’re new to investing, the idea of RSU taxation can seem daunting. Restricted stock units (RSUs) are a great way to invest, but with any form of investment, there is always the risk of taxation.
The good news is that with RSUs, understanding how they are taxed doesn’t have to be complicated. In this comprehensive guide, we will cover everything you need to know about RSU taxation policies and how to avoid being double-taxed on your restricted stocks. From how RSUs differ from stock options to the rules for calculating taxes owed and more, we’ve compiled all the information you need for a smoother transition into investing with RSUs.
What is an RSU?
An RSU, or Restricted Stock Unit, is a type of compensation offered by a company to its employees in the form of company stock. RSUs are considered “restricted” because they are subject to vesting, which means that the employee must remain with the company for a certain period of time before they are entitled to receive the stock. Vesting schedules for RSUs can vary, but they are usually based on the length of time the employee has been with the company or the achievement of certain milestones. Once the RSUs vest, the employee can either receive the stock or sell it on the market, depending on the terms of the RSU grant.
How do RSUs work?
RSUs work in a similar way to stock options, in that they give employees the opportunity to own a part of the company. The main difference between RSUs and stock options is that RSUs do not involve any upfront purchase by the employee. Instead, the company grants a certain number of RSUs to the employee, and the employee becomes entitled to receive the underlying stock once the RSUs vest.
The vesting of RSUs is typically based on a vesting schedule, which outlines the specific conditions that must be met in order for the RSUs to vest. For example, a vesting schedule might require an employee to work at the company for a certain number of years before they are entitled to receive the RSUs. Alternatively, a vesting schedule might be based on the achievement of certain milestones or the achievement of specific performance targets.
Once the RSUs vest, the employee has a few options for how to proceed. The employee can choose to receive the underlying stock and hold onto it, in the hopes that the stock will appreciate in value over time. Alternatively, the employee can sell the stock on the open market, either through a brokerage account or through a direct sale to another party. The specific rules and regulations regarding the sale of RSUs will depend on the terms of the RSU grant and the laws of the jurisdiction in which the company is located.
How are RSUs taxed?
The taxation of RSUs can be complex, and it is important to understand how RSUs are taxed before making any decisions about how to handle them. Here is a more detailed explanation of how RSUs are taxed:
- When RSUs are granted: When an employee is granted RSUs, there is typically no immediate tax consequences. This is because the employee has not yet received any stock and has not yet realized any income.
- When RSUs vest: When RSUs vest, the employee becomes entitled to receive the underlying stock. At this point, the employee must report the value of the RSUs as taxable income. The value of the RSUs is typically the fair market value of the stock on the vesting date. Your tax bill will be calculated by taking the number of shares you own multiplied by the stock price when the shares vest and adding that number to your income. From there, you’ll find your taxable income and apply the appropriate marginal income tax brackets to find your income tax bill. You’ll still owe social security and medicare taxes on the vested dollar amount as well (7.5%). There’s a tool included below to help you find out your expected tax rate.
- When the employee sells the stock: If the employee decides to sell the stock that was received from the vested RSUs, any profits from the sale will be subject to capital gains tax. The tax rate for capital gains will depend on the employee’s tax bracket and how long the stock was held before it was sold. If the stock was held for less than one year before being sold, it will be subject to short-term capital gains tax, which is taxed at the same rate as ordinary income. If the stock was held for more than one year before being sold, it will be subject to long-term capital gains tax, which is taxed at a lower rate than ordinary income.
It is important to note that the tax treatment of RSUs can vary depending on the specific circumstances and the laws of the jurisdiction in which the employee and the company are located. It is always a good idea to consult with a tax professional or financial advisor before making any decisions about how to handle RSUs.
How To Calculate Tax Bill For Your RSUs
Here’s a general overview of the process:
- Determine the fair market value (FMV) of the stock at the time of vesting. This is the value of the stock on the open market at the time that you’re allowed to sell the stock (aka when it vests), and it will be used to determine the amount of income that you need to report on your tax return.
- Calculate the amount of income that you need to report. This is equal to the FMV of the stock at the time of vesting.
- Calculate the tax that you owe. The tax that you owe will depend on your income tax rate, which is determined by your income level (including your earned income and unearned income + the value of your vested RSUs) and filing status. You can use the IRS tax brackets to determine your tax rate. For example, if you are single and your taxable income is $50,000, your tax rate would be 22% as you can see in the chart, above. Keep in mind: taxable income is the number you arrive at after any above-the-line deductions (i.e. 401k, HSA, IRA contributions, etc) and below-the-line deductions (greater of the standard deduction or your itemized deductions). Don’t confuse “taxable income” with your salary; they’re very different.
- Consider any deductions or credits that you may be eligible for. There are a number of deductions and credits that you may be able to claim on your tax return, which could reduce the amount of tax that you owe. Some common deductions include charitable contributions, student loan interest, and business expenses.
It’s important to note that this is just a general overview, and the specific tax treatment of your RSUs will depend on your individual circumstances. It’s always a good idea to consult with a tax professional or refer to the IRS website for more information.
Will I ever owe taxes when RSUs are granted?
In general, you will not owe taxes when RSUs are granted (only when the grant vests). However, there are a few circumstances under which you may have to pay taxes on RSUs when they are granted:
- If you receive RSUs in lieu of salary or wages: If you receive RSUs as part of your compensation in lieu of salary or wages, the value of the RSUs will be considered taxable income in the year they are granted. You will have to pay ordinary income tax on this amount.
- If you receive RSUs as part of a non-qualified deferred compensation plan: Non-qualified deferred compensation plans are arrangements in which you defer receiving salary or wages until a later date. If you receive RSUs as part of a non-qualified deferred compensation plan, the value of the RSUs may be subject to taxes when they are granted.
In both of these cases, you will receive a Form W-2 from your employer showing the income you recognized from the grant of the RSUs. You will need to report this income on your tax return for the year in which the RSUs were granted.
It’s worth noting that the tax treatment of RSUs can be complex, and the specifics may depend on your individual circumstances and the laws of your jurisdiction. It’s a good idea to consult with a tax professional or refer to IRS guidelines for more information on how RSUs are taxed.
Are RSUs Double Taxed?
It is possible for RSUs to be taxed twice, but this will depend on the specific circumstances and the laws of the jurisdiction in which the employee and the company are located. RSUs will never receive double taxation if you sell your company shares immediately once the vesting period has been completed.
Here is a summary of the two instances when RSUs may be taxed:
- When RSUs vest: When RSUs vest and the employee becomes entitled to receive the underlying stock, the value of the RSUs must be reported as taxable income. This means that the employee will pay income tax on the value of the RSUs at the time they vest.
- When the employee sells the stock: If the employee sells the stock that was received from the vested RSUs, any profits from the sale will be subject to capital gains tax. The tax rate for capital gains will depend on the employee’s tax bracket and how long the stock was held before it was sold. You’ll be able to calculate your capital gain by taking the value of the stock when it vests (aka, the cost basis) and figuring out how much more (or less) its worth when you eventually sell it. For example, if your stock was worth $100,000 when it vested and $110,000 when you sold it, you’d have a $10,000 capital gain.
It is possible for both of these instances to occur in the same calendar year, in which case the employee may end up paying both income tax and capital gains tax on the same RSUs. However, it is also possible for the two instances to occur in different tax years, in which case the employee would only pay one type of tax on the RSUs in each year.
As with any tax matter, it is important to consult with a tax professional or financial advisor to determine the specific tax treatment of RSUs in your situation.
How Do RSUs from Private Companies Differ From Public Companies?
RSUs from private companies differ from those of public companies in a few key ways:
- Liquidity: RSUs from public companies are generally more liquid than those from private companies. This is because the stock of public companies can be easily bought and sold on the open market, while the stock of private companies is not publicly traded and may be more difficult to sell.
- Vesting: RSUs from private companies may have longer vesting periods than those from public companies. This means that employees may have to work for the company for a longer period of time before they are entitled to receive the shares underlying their RSUs.
- Diversification: Employees of public companies may have more opportunities to diversify their investment portfolio, as the stock of public companies can be bought and sold on the open market. Employees of private companies may have more difficulty diversifying their investments, as the stock of private companies is not publicly traded.
- Tax treatment: The tax treatment of RSUs from private companies may differ from that of RSUs from public companies. This is because the tax rules for private company stock are generally more complex than those for public company stock.
Overall, the company shares you receive from RSUs from private companies tend to be less liquid and may have longer vesting periods than those from public companies. They may also be subject to different tax rules and may offer fewer opportunities for diversification.
The Pros and Cons of Private RSUs vs. Public RSUs
Here are some pros and cons of private RSUs compared to public RSUs:
Pros of private RSUs:
- Potential for increased value: Private companies may have more growth potential than publicly traded companies, as they are not subject to the same level of scrutiny from investors and analysts. This could lead to a greater potential for the value of private company RSUs to increase.
- The potential for a massive gain if the private company has a liquidity event like going public.
- Potential for tax benefits: The tax treatment of private company stock may be more favorable than that of public company stock in some cases. For example, the sale of private company stock may be eligible for the lower capital gains tax rates if certain holding period and other requirements are met.
Cons of private RSUs:
- Less liquidity: The stock of private companies is not publicly traded, so it may be more difficult to sell. This can make private company RSUs less liquid than public company RSUs.
- Longer vesting periods: Private companies may have longer vesting periods for RSUs than public companies, which means that employees may have to work for the company for a longer period of time before they are entitled to receive the shares underlying their RSUs.
- Fewer opportunities for diversification: Employees of private companies may have fewer opportunities to diversify their investment portfolio, as the stock of private companies is not publicly traded.
Overall, private company RSUs may offer the potential for increased value and tax benefits, but they may also be less liquid and have longer vesting periods than public company RSUs. It’s important to carefully consider these pros and cons before accepting an offer of private company RSUs.
When would you make your tax payment following the vest date of your RSUs?
The timing for making your tax payments for your RSUs depends on whether your RSUs are qualified or non-qualified.
Qualified RSUs:
Qualified RSUs are also known as “incentive stock options” (ISOs). If you receive qualified RSUs, you will generally not have to pay taxes when the RSUs vest. Instead, you will recognize taxable income when you sell the shares you received from the RSUs. The amount of taxable income will be the difference between the fair market value of the shares on the date you sell them and the price you paid for the shares (which is typically zero for qualified RSUs).
Non-qualified RSU taxes:
Non-qualified RSUs are not ISOs. If you receive non-qualified RSUs, you will generally have to pay income taxes on the value of the shares when they vest, even if you do not sell the shares. The value of the shares is considered taxable compensation, and you will have to pay ordinary income tax on this amount.
In either case, you will receive a Form W-2 from your employer showing the income you recognized from the vesting of your RSUs. You will need to report this income on your tax return for the given year in which the RSUs vest and make the tax payment in April when you file your taxes. You’ll always owe taxes on any RSUs that vest before the end of the year on that year’s tax liability. It’s important to plan for this for every tax year that you have RSUs vesting.
It’s worth noting that the tax treatment of RSUs can be complex, and the specifics may depend on your individual circumstances and the laws of your jurisdiction. It’s a good idea to consult with a tax professional to receive proper tax advice, a financial advisor to give you investment advice, or refer to IRS guidelines for more information on how RSUs are taxed.
Conclusion
In conclusion, restricted stocks and RSUs can be a great financial tool for investors. However, understanding the taxation associated with these types of investments is essential to maximizing your returns. With the comprehensive guide to RSU taxation provided here, you should now have all of the information necessary to make informed decisions about how best to structure your holdings in order to maximize tax efficiency while still achieving your desired investment outcomes.