What are Restricted Stock Units?
Restricted Stock Units (RSU) are the most common form of equity award issued by companies to tech professionals in recent years. It may seem like another magical perk in Silicon Valley, but it is a real type of equity compensation in which the employer issues company stock to employees. RSUs are ‘restricted’ because the stock units do not have any tangible value on the grant date (the date on which the RSU is issued) and the ownership is progressively transferred to the employees based on a predetermined vesting schedule. RSUs encourage company loyalty, carrying you through those late, extra hours you may spend working.
They may feel like a lucky talisman, an untouched pool of wealth that is already saved for you, but they come with a little dark side. They vest in the future, so if you leave your job, you will probably lose them. RSU is a promise by your employer to ‘grant’ you company stock at a specified time. The longer you stay, the more company shares you will be entitled to receive as compensation. You will not have voting or other ownership rights until the shares get vested in your brokerage account on the vesting date per your employer’s schedule.
What makes RSUs advantageous is that, unlike Employee Stock Purchase Plans or stock options where you have to purchase shares to own equity in the company, RSUs are essentially a cashless exercise – meaning you don’t have to use any of your own funds to receive shares. Also, unlike options (which can go underwater), it is unlikely you will lose all the value on your RSUs even if share prices fall in the future. That is, unless your company files for bankruptcy.
Say the RSU grant price is $30 but the price falls to $20 by the time the stock vests in your account, your RSU is still worth $20. This is unlike options where if the market price falls below the strike price, the options become worthless.
How do Restricted Stock Units Work?
Time-based RSU vesting schedules are the most common with companies generally offering grants that get vested over a predetermined period subject to a ‘vesting cliff’. This is the period during which an employee is required to remain employed in the company before the first part of the grant vests in his account.
For instance, if an RSU award is based on a four-year equal schedule with a one-year vesting cliff, you will need to work in the company for at least a year to attain ownership of the first lot of shares. You will almost always lose all unvested shares from your RSU grant when you resign from the company.
RSU vesting can also be performance-based when the RSU grants get vested all at the same time. This happens when an employee achieves a predetermined milestone or other set performance goals.
A hybrid vesting schedule incorporates both time-based and performance-based measures.
How are RSUs taxed?
RSUs become taxable on the vesting date and not the grant date, under current tax law. The market value of the shares on the vesting date is considered an ordinary income and gets reported on your W-2. Companies are subject to a mandatory supplemental wage withholding of such income.
The most common withholding method involves a net share settlement process in which companies withhold a certain number of shares, the value of which covers a portion of the taxes owed on such vesting, before transferring the remaining vested shares to your brokerage account. Since the mandatory withholding may not be sufficient to cover the entire tax liability, your company might also provide an option to adjust (increase) your withholdings to cover any shortfall.
Additionally, you will owe capital gains tax when you sell your RSU stock. If you sell the shares after one year of the vesting date, you will realize long-term capital gains or losses. Otherwise, short-term gains or losses will apply. While long-term capital gains may be taxed at a more favorable rate, your short-term capital gains do not receive any such preferential treatment and get taxed at marginal rates.
When should I sell my RSUs?
While regular RSU vesting can increase your portfolio value, it also increases the concentration risk in your portfolio. You should also factor in your own financial goals, comfort with investment risk, and tax bracket, before deciding how much of your company stock you want to own. The financial health of your company and your belief in its future growth is also relevant, but your own financial security should guide you.
When selling shares to reduce concentration risk in your portfolio, your capital gains tax liability will increase. Moreover, if you fall under a higher tax bracket, the company wage withholding might not cover your tax liability. You will need to either make estimated tax payments or increase your withholdings to avoid penalties for any underpayment of taxes.
Determining what you will do with the sale proceeds of your shares should be the cornerstone of your RSU selling strategy. If the sale proceeds are just going to lie idle in your bank account, you might be better off not selling the shares, especially if the share price continues to rise. On the other hand, if you need the cash to pay off debts, or pay a down payment on your mortgage, or if you would like to re-invest the money in other ventures, it may be wiser to cash your RSU holdings.
RSUs may provide an opportunity to capitalize on what you have in front of you and magnify what that can mean for your future. We want to see you succeed and build wealth. Contact us to get a customized strategy to help you take a proactive tax approach to help optimize your financial goals. By partnering with us you can learn more about creating a strategy and get specific advice regarding which RSU shares to sell to meet your goals.
C-J Advisory, Inc. is an investment adviser in San Jose, CA. C-J Advisory, Inc. is registered with the Securities and Exchange Commission (SEC). Registration of an investment adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. C-J Advisory only transacts business in states in which it is properly registered or is excluded or exempted from registration. A copy of C-J Advisory’s current written disclosure brochure filed with the SEC which discusses among other things, C-J Advisory’s business practices, services and fees, is available through the SEC’s website at: www.adviserinfo.sec.gov. C-J Advisory does not provide tax or legal advice. Nothing provided herein constitutes tax or legal advice. Individuals should seek the advice of their own tax or legal advisor for their specific situation. Investments in securities entail risk and are not suitable for all investors. This is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction.