Restricted Stock Units | If you’re wondering how restricted stock units work, what is stock compensation, what are RSUs or what the taxation of restricted stock units looks like, we’re here to give you answers to your questions.
Restricted Stock Units, RSUs, are one type of stock compensation that companies can offer to their employees. This stock compensation allows your company to grant you shares, or RSUs. RSU compensation is different than the other common program many publicly traded companies offer to their employees, called an Employee Stock Purchase Plan (ESPP). ESPPs afford you an opportunity to buy shares of the company you work for at a discounted price.
What are RSUs?
How restricted stock units work?
Taxation of restricted stock units
RSUS vs ESPPs
What are RSUs?
Restricted Stock Units are a way for an employer to compensate employees by granting them actual shares of company stock. The grant is "restricted" because it is subject to a vesting schedule. Therefore, the employee typically only receives the shares after the vesting date. Once the shares are delivered, the grant is considered compensation income and your taxable income is the market value of the shares. When you later sell the shares, you will also recognize income on any appreciation over and above the market price of the shares back on the vesting date. Your holding period will determine whether the gain is subject to short-term ordinary income rates, or lower long-term capital gains rates.
How restricted stock units work?
Vesting schedules are often time-based, requiring you to work at the company for a certain period before your RSUs begin to vest. A common schedule is a "graded" vesting schedule, which means the vesting of the grant occurs in several portions. Vesting schedules can also have "cliff" vesting, which means 100% of the RSU grant vests after you have completed a specific stated service period of say three or four years. And finally, the vesting schedule can also be performance-based, meaning tied to company-specific or stock-market targets.
Taxation of restricted stock units
With RSUs, you are only taxed when the shares are delivered, which is almost always at vesting. Your taxable income is the market value of the shares upon vesting. For the taxation of restricted stock units, the grant is considered compensation income, and is subject to mandatory federal, state, and local income and employment tax withholding. The most common practice of paying these taxes is by surrendering the necessary amount of newly delivered shares back to the company. This holds or "tenders" shares to cover your tax obligation. When you later sell the shares, you will also recognize income on any appreciation over and above the market price of the shares back on the vesting date. Your holding period will obviously determine whether the gain is subject to short-term ordinary income rates, or lower long-term capital gains rates. You’ve got to have a plan if you’re working on minimizing taxes.
RSUS vs ESPPs
While RSU’s may not be as complicated as ESPP plans, the tax planning for them is just as important. Understanding how restricted stock units work and the taxation of restricted stock units—including when your shares will vest—gives you the opportunity to plan in advance to ensure you can limit your overall tax liability.
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