Restricted Stock Units (RSUs) are a popular form of employee compensation, especially in high-growth industries like tech. RSUs offer employees a stake in the company without requiring an upfront investment. However, to truly benefit from RSUs, it’s crucial to understand how they work, how to manage them, and the tax implications they carry. With the recent migration to East Tennessee, our team has had the opportunity to advise clients more frequently who have earned this type of compensation.
Simply put, RSUs are company shares given to employees as part of their compensation package. However, employees don’t receive these shares right away. Instead, they must go through a vesting period. Think of vesting as a waiting period where the shares gradually become yours over time.
For example, if you receive 1,000 RSUs with a four-year vesting schedule, you’ll earn 250 shares each year. This structure incentivizes employees to stay with the company longer and aligns their interests with the company’s success.
Once your RSUs vest, they become actual shares that you own, deposited into a taxable brokerage account. Managing these vested RSUs wisely is important. After vesting, you have a few options:
1. You can hold onto the shares, hoping they will increase in value over time (though the share price can also decrease).
2. You can sell some of the shares to diversify your investment portfolio and reduce risk.
3. You can sell all of the shares to fully diversify away from the company.
Each choice has its own set of considerations, and the best strategy depends on your financial goals, market conditions, the future outlook of the company, and tax implications.
Let’s highlight the tax implications of RSUs, as they are commonly misunderstood.
When your RSUs vest, their fair market value on the vesting date is treated as ordinary income, taxed at your marginal tax rate. This means you’ll owe income tax on the value of the shares as of the vesting date. The vested shares are subjected to mandatory tax withholding to cover taxes. If your income is less than $1 million, the mandatory withholding is set at 22%. For income above $1 million, the excess mandatory withholding is set at 37%.
For example, if 250 shares vest and each share is worth $60, you’ll report $15,000 as ordinary income. This amount is subject to federal, state, and local taxes, as well as FICA (Social Security and Medicare) taxes. It’s essential to plan for this tax hit, as it can be substantial. Some companies offer a “sell to cover” option, where you can sell enough shares to cover the tax bill right away, simplifying the process. If not, you’ll need to consult a tax professional.
The complexity doesn’t end there. When you eventually sell your vested shares, any gain or loss compared to the fair market value at vesting will be treated as a capital gain or loss. In the above example, anything above or below $60 per share will have a capital gains impact. If you hold the shares for more than a year after vesting, any profit will be taxed at the lower long-term capital gains rate (0%, 15%, 20%, or 23.8%), which is generally more favorable than the ordinary income tax rate. Understanding these tax implications is crucial to maximizing your financial benefit from RSUs.
Given the tax intricacies involved, it’s highly beneficial to have an advisor who is well-versed in tax and investment matters. Professionals with CPA (Certified Public Accountant) or EA (Enrolled Agent) designations can help navigate the tax landscape, ensuring you comply with tax laws while optimizing your financial outcomes. They can assist in planning for the tax liabilities that come with vesting, advise on the timing of share sales to minimize taxes, and integrate your RSUs into your overall financial plan.
RSUs can be a powerful component of your compensation and a significant step towards building wealth. However, their benefits are best realized with careful management and a thorough understanding of the associated tax implications. Working with our team at LeConte, who have expertise in tax, planning, and investments, can make a substantial difference. We can help you navigate the complexities and make the most of your RSUs. By vesting in your future wisely, you can maximize your financial rewards and achieve your long-term goals.
