Restricted stock units (RSUs) are utilized as a supplement to employee benefits packages. While receiving corporate shares is advantageous and even inspiring, other aspects must be considered. Understanding how RSUs will affect your investment and tax is crucial.
While your restricted stock units are vesting, you should thoroughly understand how your restricted stock functions and how it might benefit you. Now is the moment to establish a strategy for managing limited stocks inside your financial plan.
In this post, we’ll explain what restricted stock units are, how they affect your taxes, and the best ways to maximize their benefits to meet your specific short- and long-term financial goals.
What Are RSUs?
The term restricted stock unit (RSU) refers to an award of stock shares, commonly as a form of employee pay, that are subject to certain criteria, such as a vesting time, prior to being transferred to the owner. A restricted stock unit is a commitment to issue one share of stock for each unit awarded to an employee, provided the employee meets specified conditions. RSUs are said to vest once certain requirements are met, at which point the business issues the promised shares.
The majority of technology companies, including Tesla, Google, and Amazon, employ RSUs to recruit and retain top people. These businesses also use RSUs to align employee interests with company objectives. Since the future stock price worth of RSUs is contingent on the company’s stock’s fair market value, this sort of remuneration drives employees to perform well.
Since RSUs are useless until vesting, the corporation can offer incentives to employees by giving them RSUs without paying them anything.
How Do RSUs Work?
An RSU is granted to an employee as an incentive to remain with the firm and improve its performance. If the company performs well, the stock price will rise, hence increasing the value of the employee’s RSUs. It’s a win-win situation.
Typically, the corporation grants the employee a predetermined number of shares of company stock according to a vesting schedule. Here’s an illustration:
John receives an employment offer from a company that includes a salary, benefits, and 1,000 RSUs. John will receive 200 shares annually for the next five years. As these shares vest annually, their Fair Market Value at the time of vesting is added to John’s annual taxable income, and John is subject to ordinary income tax on this amount.
As his shares vest, John can opt to sell them, keep them, or sell some and keep the rest. They essentially become generic stocks in every sense. If the value of the shares improves after they vest and John decides to sell them, he will be subject to capital gains tax on the difference between the Fair Market Value in the year of vesting and the sale price.
Types of RSUs
Additionally, there are two types of RSU vesting schedules:
“Graded” Vesting Schedule. In accordance with this timetable, RSUs vest periodically over a number of years. They could vest equally or according to a different timetable (for instance, 40% in the first year and 20% in each of the following three years).
“Cliff” Vesting Schedule. With a “Cliff” vesting plan, all RSUs vest simultaneously. This “Cliff” could be triggered after a specified time of service or connected to an individual’s or company’s performance.
Normally, vesting ceases with separation from an employer. Nonetheless, some employers will accelerate vesting by one year (or more) as part of a severance or retirement compensation (or potentially in the case of death or disability).
Similar to employer contributions to 401(k) plans, RSUs do not belong to you until they have been vested. In general, if you work for a publicly traded company, the vesting schedule for your RSUs is either a “cliff” schedule (in which all of your RSUs vest at once after a certain period) or a “graded” schedule (in which your RSUs vest gradually, for example, 25% per year over four years) or a combination of the two. Additionally, working for a private corporation may encounter the “double-trigger” vesting schedule. Even if you meet the normal cliff and/or graded schedule requirements, your RSUs will not vest until a certain liquidity event occurs. IPOs are the most typical type of liquidity event.
Some RSU plans may also include vesting provisions based on the company’s particular performance indicators. Ensure you fully comprehend it if it contains additional features.
Moreover, you must comprehend what will happen to your vested and unvested RSUs when you leave the organization. Sometimes it may be advantageous to remain until additional RSUs vest.
Can I Make Charitable Donations of Restricted Stock Units?
You cannot give RSUs that have not been vested. However, since you own the company’s shares as a whole, you can donate vested RSUs to qualified nonprofits.
Donate equities that were appreciated and purchased at least a year ago. Ask your stock administration team if you are permitted to donate company stock outside of the trading window if you are subject to blackout periods.
Donating corporate stock is a win-win proposition. Your preferred charities receive much-needed funding. And you gain monetarily in two ways:
Donating corporate shares lowers your concentration on company shares.
Donating company stock lowers your taxable income in two ways.
Because you own the company’s shares outright, you may give away RSUs that have been granted vesting. Financial contributions are tax-deductible only if the beneficiary is a qualified charity.
Consider gift tax problems. You can give up to $15,000 to an individual in 2021 without incurring gift tax liability (“annual exclusion gift”). If you have two siblings, you can give each sibling $15,000 invested RSUs, for a total of $30,000. You can make gifts in excess of the $15,000 annual exclusion level, but you must record them on your tax return. You are not required to pay gift taxes until you exceed the lifetime donation limit ($11.7 million in 2022).
The recipient does not have to pay taxes until they sell the stocks, at which point they may be subject to capital gains taxes. The recipient’s tax liability depends on your cost basis (the stock price when the RSUs vest), the length of time you owned the stock before gifting it, and the stock’s value on the date of the gift.
Taxes Applied To Restricted Stock Units
Restricted Stock Units (RSUs) are taxed differently from Options and Employee Stock Purchase Plans (ESPP).
Compared to these other kinds of equity compensation, RSU taxes is quite simple, but there are a few special aspects that everyone should be aware of. RSU income is typically subject to withholding. Since RSUs are a form of compensation, they are taxable, and because RSU income is considered supplemental income, the withholding rate can range between 22% and 37%. If you do not want any withholding, your employer may be allowed to dispose of a portion of the shares to fulfill the withholding obligation (in essence, you pay the withheld tax by having the company take it out of the shares). Without withholding, you may end up paying income taxes quarterly, which could be a new experience for you.
If you reside in a high-tax state, up to fifty percent of your RSU income could be taxed. State and local income taxes may apply to RSU income in addition to federal income tax.
Your RSU may generate a capital gain. Suppose you sell the stock for more than its fair market price (the amount they are worth on the open market). If the transaction causing the gain occurs within a year of the vesting date of the RSU shares, the Internal Revenue Service classifies the gain as short-term. Short-term capital gains are taxed at the same tax as ordinary income. If the transaction happens more than a year after the date of vesting, long-term capital gains taxes (currently capped at 30%) are applicable.
In general, the value of your RSU shares corresponds to the value of your employer’s stock on the market. After your employer issues, you restricted stock units, and you should discuss this factor with a financial specialist (and possibly a tax professional).
With the passage of the Tax Cuts and Jobs Act, the Internal Revenue Service (IRS) modified its regulations so that just 22% of supplemental income (such as bonuses, commissions, or stock compensation) up to $1 million must be withheld at the federal level, down from 25%. This means that if your salary is less than $1 million per year and you are paid in RSUs, your employer will likely only report 22% of the RSU value to the IRS. The typical way in which an employer achieves this is by selling shares of your RSUs on the vesting date. Suppose you were promised RSUs of $100,000, which would be 100 shares of stock at $1,000 apiece. On the vesting date, your company would sell 22% of these shares and use the proceeds to meet your tax withholding obligation. Due to the company selling 22 shares to cover taxes, instead of receiving 100 shares, you would receive 78 shares. Although the withholding obligation is merely 22%, the amount of tax you owe is actually determined by your tax rates.
Although paying a substantial amount of taxes on income, bonuses, and restricted stock unit awards is not the worst problem to have, the quantities might be staggering.
It’s possible that you didn’t have enough taxes withheld from your salary in a year when you got a big bonus or when your restricted stock units were vested. Reduce your exemptions, have extra money deducted from your salary or pay estimated taxes quarterly to avoid any unpleasant surprises come tax time by consulting with a tax professional.
Should I Expect Tax Withholding From My RSU Payout?
The majority of employers do not withhold taxes based on your W-4 rate but instead use the flat IRS rate for supplemental wages. With effect from 2022, the rate will be 37% on earnings over $1,000,000 and 22% on earnings over $1,000,000.
Please be aware that if your RSU income is taxed at a rate of more than 22% when you submit your taxes, depending on your other tax withholdings, you may owe additional taxes. If you foresee being in this situation, you may try withholding additional federal taxes from your paycheck or saving aside funds to satisfy your tax obligation at the end of the year.
Three Options For Managing Your RSU Taxes
Option 1: Contact Human Resources to modify your withholdings.
This is not always possible, but adjusting your withholdings is the simplest approach to ensure you’re paying adequate tax. Contact your HR representative or whoever oversees stock compensation at your company. Adjust your withholdings according to your marginal tax bracket or the highest tax bracket that your pre-RSU compensation will reach. For instance, if you earn $250,000 in salary and an additional $50,000 in RSU income, you will need to modify your federal withholding to 35%, and your California state withholding should be adequate for the second $50,000 of income (or more, including pre-tax deductions). If you’re in between tax rates, you can choose the higher withholding if you’d rather receive a tax refund or the lower withholding if you’d rather save a bit more to cover your tax liability.
Option 2: Sell RSUs upon vesting.
This is essentially the same method as Option 1, but the trades are executed manually rather than automatically. This is an excellent alternative for ensuring that you can pay your taxes regardless of huge movements in the stock market. Depending on the frequency of your stock’s vesting, you may encounter trading window issues where you cannot trade shares on specific days. We advise analyzing the open trading periods early in the year and establishing a timetable that can be adhered to.
If the value of your RSUs has changed since they first vest, you may owe additional taxes.
Option 3: Sell RSUs to satisfy tax obligations at tax time.
If you have faith in your company and believe the stock price will continue to climb, you might consider selling your shares at tax time. This can be advantageous if your stock price continues to rise, but we have seen this method backfire because you run the risk of needing to sell during a very precise time frame.
You should remain informed of any closed trading windows that would prevent you from trading and consult a CPA to ensure that you will not incur tax penalties for underpayment throughout the year.
How Can RSUs Avoid Taxes?
Transfer to a State Without a State Income Tax
This technique is not foolproof, and it will take extensive planning and the assistance of an accountant (as it can result in an audit if not done properly). Nonetheless, relocating to a state with no state income tax may be a viable way to lower the taxes you owe on future RSUs that vest.
Moving to a state without a state income tax may help you to avoid some state income taxes, assuming your employer will allow you to work in another state (Washington, Texas, and Nevada, to name a few). But you’re out of luck if you move after a vesting event has occurred.
Suppose you move before your stock options have vested. In that case, the Internal Revenue Service or your state tax agency will prorate your state income tax liability depending on the number of years you have lived in each state from the award date.
Again, and we cannot emphasize this enough, you should contact a CPA to assess if moving to another state for the tax benefits would be worth the trouble. Suppose you have recently received a grant for several million dollars that will not vest for another year, and your employer will allow you to transfer out of a state with high-income taxes. In that case, you may save several hundred thousand dollars by doing so.
Utilize Your Health Savings Account to Its Full Capacity (HSA)
If your health insurance plan has a high deductible, you may be eligible to open an HSA and put away pre-tax cash that will grow tax-free as long as they are used for medical costs. After age 65, you are permitted to withdraw funds without penalty; you will only be required to pay taxes.
In 2021, families can donate a maximum of $7,200. While this technique is similar to donating the maximum to your 401(k), if you and your spouse each contribute $7,200 to your HSA and $19,500 to your 401(k) on a pre-tax basis, you dramatically reduce your taxable income. This should lower the tax burden associated with your RSUs.
Note: If you do not have (and cannot obtain) an HSA, your employer may offer a Flexible Savings Account (FSA). RSUs are subject to various laws, but they can also be used to delay income and decrease tax liability. There is an excellent post by NerdWallet explaining the distinctions, and here you can locate the link.
Second Note: If you are a parent, we strongly advise you to maximize your Dependent Care FSA. This allows you to set aside funds before taxes and utilize them to pay for daycare or other similar expenses. If you max out this vehicle, it may save you $2,000 to $3,000 yearly in taxes.
Create a Donor-Advised Fund (DAF)
Typically, this vehicle is employed when the value of an asset has increased. How does this vehicle operate? You donate an asset (usually an equity position) to the DAF. The DAF then sells the item tax-free and invests the revenues in accordance with your risk aversion. You can request payments to be made to various charities over time, and you can do so anonymously.
It is a terrific vehicle since you receive an instant tax deduction and can make donations over time. It’s usual to designate children or other family members as DAF successors, allowing them to choose charities to support after your death. As previously said, this is primarily utilized for highly appreciated shares, but it’s still a fantastic philanthropic vehicle if you’re seeking to minimize RSU taxes. Schwab and Fidelity facilitate the creation of DAFs, which are also reasonably inexpensive.
RSUs are taxed differently than other kinds of equity compensation, such as stock options. Regarding RSU taxes, there is no immediate tax liability when restricted stock units are granted. The tax treatment of RSUs is only applicable upon vesting and receipt of the real stock shares. This post should have supplied you with some helpful tips.