RSU Tax Treatment: Equity-Based Compensation - Restricted Stock Units
With stock markets fluctuating wildly, it's especially important to understand the financial and tax implications of any company stocks your employer might offer. Restricted stock units, or RSUs, have become particularly popular in recent years. A 2017 survey by Ayco's Compensation and Benefits group showed 72% of companies use RSUs, up from 37% just 10 years earlier.
So, how do RSUs work? They're a type of equity-based compensation in which there is a period between when you're granted shares of company stock and when you actually gain ownership (vesting) in those shares. RSU vesting is often contingent on a minimum tenure with the company, and the actual value depends on the market price of your company shares at the time they vest rather than when the RSUs are granted.
RSU tax treatment is relatively straightforward. You don't owe any taxes until they vest — since the shares are not technically yours until then. In the year in which they vest, the value of the shares is considered ordinary income and is taxed as though you had received the same amount in cash. If you decide to hold onto the shares, any change in value is taxed as capital gains or losses when you sell the shares.
Let's look at an example to illustrate better what RSUs are, how they work, and the choices you have when you gain ownership of these shares.
Emmitt is offered a compensation package with a $75,000 annual cash salary and a grant of 4,000 RSUs that vest quarterly over the next four years, or 1,000 per year. Shares trade at $25, so Emmitt's total annual compensation can be estimated to be about $100,000 per year assuming a static stock price.
Depending on how the company performs, the value of Emmitt's actual compensation can vary. If the company shares drop in value, for example, the value of his total compensation will be lower than expected. Alternatively, if the company shares pop, Emmitt will find that his compensation is higher than expected and may need to adjust his tax withholding. In either case, it will be crucial for Emmitt to understand RSU tax implications.
Your company shares make up a large amount of your net worth. While each situation is different, holding more than 10% of your portfolio in your employer's stock, or any single stock, poses a significant risk to your financial well-being in the long run. The exact threshold is your choice, but it's wise to set an upper limit for any single stock.
You want skin in the game. While we do not recommend holding a concentrated position in your employer's stock, it's understandable to have some skin in the game with a company where you're investing a lot of time and effort.
Second, it's human nature (known as the endowment effect) to have a bias toward things we already own and to hold onto things we wouldn't normally buy. Would you use all of your $25,000 cash bonus to buy your employer's stock? If the answer is no, then don't hang onto vested RSUs just because the compensation was given to you as stock rather than cash.
When time and money are scarce, even those of us who usually are good at managing our finances can make poor decisions. That's why it's more important than ever to review your goals and plan ahead for the best opportunity at a successful outcome. This is true whether it concerns your RSUs, your overall finances or any other life goals.
This article was written by Daniel Lee from equities.com and was legally licensed through the NewsCred publisher network. Please direct all licensing questions to legal@newscred.com.