Clients often ask us how to handle Restricted Stock Units (RSUs) and what the tax consequences are. Let’s review why selling your RSUs as soon as they vest is often the best option.
RSUs are a form of equity compensation. Companies offer RSUs to their employees as a way to provide them with an ownership stake in the company. RSUs are different from traditional stock options. They do not give employees the option to purchase shares at a set price. Rather RSUs require employees to wait for a certain period of time before they can receive the shares.
When you are granted RSUs, the fair market value of the shares at the time of grant is not considered taxable income. Instead, you pay taxes on the value of the shares when they vest, which is the date that you become entitled to receive the shares. The fair market value of the shares on the vesting date is considered ordinary income. It is subject to federal and state withholding taxes in much the same way as a cash bonus would be.
When you sell the shares, the difference between the sale price and the fair market value of the shares on the vesting date is considered a capital gain or loss. If you hold the shares for more than a year before selling them, the gain or loss is considered a long-term capital gain or loss. It is subject to lower tax rates. If the shares are sold before you have held them for a year, the gain or loss is considered a short-term capital gain or loss. It is taxed at ordinary income tax rates.
Tax Withholding Surprises
Employers are required to withhold at a flat 22% tax rate for federal income tax purposes. They usually accomplish this by selling some of your shares. RSUs are what the IRS calls “supplemental compensation” and require a flat withholding rate regardless of your withholding elections.
Many of our clients are in a marginal tax bracket much higher than 22%. And this can lead to a surprise come tax time when you need to pay the difference.
More and more companies are now offering a once a year election to increase your withholding rate on RSUs. If you’re offered this opportunity, consider it carefully to avoid a large balance due in April.
Why You Should Consider Selling RSUs as Soon as They Vest
So what should you do with these RSUs once they have vested?
We often ask clients the following question:
“If you were to receive the same money as a cash bonus, would you choose to purchase company stock or use the cash for some other purpose?”
Often, clients would rather use the cash for some other purpose like their emergency savings fund, home improvement, travel, etc.
From a tax perspective, if you sell your shares on the same day as vest, you likely won’t incur any additional capital gain since we would expect the sales price to be close to the fair market value on the date of vest. (If you have blackout dates around the time you normally vest, your mileage may vary here and you’ll want to review how much gain you’ll have on a sale.)
And, if you do decide to sell your RSUs, make sure you’ve estimated your tax liability. You might find it best to hold back 10-15% of the proceeds to cover your tax bill. In a down market, this can be especially important. If your company’s stock price falls and your shares are worth a lot less, it can be difficult to come up with the cash needed to pay your taxes come April 15th.