RSUs: The Basics

No other type of equity compensation is as straightforward as RSUs. They vest when they vest, you cannot file an 83(b) election, and taxes are automatically withheld at vesting. The only two levers of control with RSUs are your salary negotiating skills and timing the sale of vested shares. 

RSUs are usually issued for later stage companies, and often these companies are already publicly traded. 

Most commonly, initial RSU grants vest over 4 years, with ¼ of all shares vesting after one year of employment (also known as “the cliff”), followed by quarterly, or monthly, vesting of the remainder. Any subsequent “refresher” grants issued after one year of employment are likely to have simple quarterly vesting without the cliff. 

Tax Effects of RSUs:

At grant, there is no taxable event as no actual shares are transferred. Your grant might have an estimated value of future vests, but is usually stated in the number of shares that will vest on certain dates in the future. If the stock price increases by the time vesting comes, that is a bonus. If the stock price decreases, your total compensation figure took an unfortunate dip.

Example: You are set to receive 1,000 shares over the next 4 years. The shares are currently valued at $100, therefore the grant is valued at $100,000. The only constant is the number of shares, and not the total value. If the share price doubles, the value of your grant doubles along with it - and vice versa.

When shares vest, the entire value of vested shares is considered earned income, and that income is subject to tax withholdings. Here are the main withholding components:

-Federal income tax at 22% or 37% (before or after $1m in compensation, respectively).

-State income taxes at predetermined rates (10.23% for California).

-Applicable Medicare and Social Security taxes.

Funds needed for the withholdings are usually generated by selling a portion of your shares on your behalf. Your basis in the shares is their value (stock price) on vesting date. Net shares received after all applicable withholdings get deposited into your trading account. 

Example: If you have 100 shares vesting next week, you may only end up with 70 shares, since 30 shares were automatically sold to cover your tax withholding.

Note: Federal income tax withholdings for RSUs are at fixed rates. These withholding rates might not be sufficient to cover the actual tax bill, especially for high earners. Consult your tax advisor to evaluate whether you are sufficiently withheld.

When you sell the shares, any gain or loss (if any) over the price at vesting will be reported on your tax return as capital gains/losses:

-Short term capital gains rates (same as regular income tax rates) if sold within one year after vesting; a short term capital loss if sold at a loss. 

-Long term capital gains rate (lower than regular income tax rates) if sold later than one year after vesting; a long term capital loss if sold at a loss.

If shares are sold close to the time of vesting, and there has been very little price change, then the tax impact is very minimal. For example: Shares vest at $50 per share and you sell the next day at $51. You are only paying capital gain taxes on the $1 of gain. Many times there is “overthinking” when it comes to short and long-term capital gains when it comes to RSUs. Tax rates are important to factor in when making sales, however they are only one piece of the puzzle. A 40% tax rate is a lot different on a $10 gain versus a $100,000 gain.

Sales of RSU shares are also subject to wash sales rules; be mindful when trying to sell at a loss when there is another vesting, ESPP purchase, or options exercise 30 days either before or after the sale. Consult your tax advisor to determine if this is of concern for your situation.

Financial Planning for RSUs:

If you were given a cash bonus today, would you use all of the money to buy more shares of your company stock in your personal investment account? If the answer is no, then there is certainly a strong argument to be made to sell a portion of your RSUs. Failure to do that is what is known as falling into the “RSU trap” - by not selling any vested shares you are effectively using your entire bonus to buy more shares of your company’s stock instead of doing what you would normally do with a cash bonus (save, invest, travel, donate).

When deciding on what percentage of vested RSUs should be sold, consider the overall position size and general diversification of your portfolio. 

If vesting takes place well outside of your trading window but an immediate sale is in your plan of action, explore whether participating in a 10b5-1 plan is an option. It would allow you to sell shares upon vesting while specifying minimum price, size of the order, etc. These plans are usually set up through the custodian of your shares (E-trade, Schwab, Fidelity, etc.)

RSUs can be an excellent wealth building tool, especially when employees are aware of the implications surrounding them. Too often we see shares vesting and piling up, resulting in an overly concentrated position in the employer's stock. Sometimes it works out (when stock price goes up), and sometimes an opportunity to diversify is missed (when stock price takes a dip).  

We encourage you to reach out to your financial or tax professionals to plan for RSU grants and holdings.