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Steve Pitchford October 16, 2023 No Comments

What is an RSU? | Restricted Stock Units, RSUs and Stock Options 10.16.2023

Restricted Stock Units (RSUs) can be a significant component of an employee’s compensation package. But what is an RSU package? Do you have an RSU strategy? How are RSUS taxed? When are RSUS taxed? How should you consider RSUs taxation? What are stock options, and why do employers offer RSUs vs stock options? How do you plan most effectively when your RSUs vest? Net worth means what in regards to an RSU selling strategy?

The 411 on Restricted Stock Units (RSU) tackles these questions and more. What is an RSU? | Restricted Stock Units, RSUs and Stock Options

What is an RSU?
RSU vs Stock Options – What are stock options?
What Is the Taxation of Restricted Stock Units?
RSU Strategy
How Can I Most Effectively Plan
How can we help
Learn more

What is an RSU?

RSUs, also commonly known as restricted stock units, or restricted stock shares, are a form of stock based compensation whereby an employee receives rights to shares of stock in a company that are subject to certain restrictions. These units do not represent actual ownership or equity interest in the company and as such hold no dividend or voting rights. (1) However, once the restriction is lifted, the units are converted to actual company shares and an employee owns the shares outright (same as traditional stock ownership). Learn more about RSU tax selling strategy.

The lifting of restriction on the units is generally based on a vesting schedule. Most vesting schedules will fall into one of two categories:

Time-based: based on the period of employment. Common time-based vesting schedules are between three to five years and are either pro-rata or “cliff” based. For a “cliff” based schedule, all shares vest fully at the end of the schedule.
Performance-based: based on the company achieving a performance goal. Common performance-based vesting schedules are based on a company achieving a particular stock price or a return on equity, or earnings per share.

*There is a hybrid-approach between time-based and performance-based known as time-accelerated. Vesting is on a time-based schedule but may be accelerated by the company achieving a performance-based goal.

RSUs vs stock options | How Are RSUs Different Than Vested Stock Options?

When most people think of stock based compensation, vested stock options, or the right to buy a company’s stock at some future date at a price established now (the strike price), are typically what first comes to mind.

Historically, vested stock options have been the most popular form of stock based compensation. And up until 2004, stock options merited favorable accounting treatment as a company could avoid recognizing compensation expense by issuing the options.

In 2004, this loophole was eliminated and subsequently RSUs/restricted stock shares, aka units, emerged as the preferred form of equity compensation.

RSUs and stock options have some notable differences:

Net Worth Means — Rsus vs stock options | This table lists three areas of difference between rsus and stock options: risk, term, and taxation.

Two scenarios illustrate RSUs vs stock options:

Scenario 1: An employee is granted 1000 RSUs when the market price of the company’s stock is $10. When the RSUs vest, the stock price has fallen to $8. The shares are still worth $8,000 to the employee.

Scenario 2: An employee is granted 1000 stock options with a strike price of $10. During the window to exercise these vested options, the market price of the stock is always below $10. These options will expire worthless to the employee.

*There are many other forms of nontraditional compensation, such as Stock Appreciation Rights (SARs), Phantom Stock, and Profit Interests. None of these are as widely used as RSU and Stock Options and are not a focus here.

What Is the Taxation of Restricted Stock Units?

RSUs taxation is based upon delivery of the shares, and taxes must be paid upon vesting (i.e., when the restriction has been lifted).

The shares’ fair market value is included in an employee’s taxable income as compensation at the time of delivery. The taxation of restricted stock units is identical to normal wage income and as such, is included on an employee’s W-2. (3)

Taxation of Restricted Stock Units and RSU vs stock options — Taxation of restricted stock units. It’s important to have an RSU tax strategy and know if you will need to sell to cover tax

The shares are subject to federal and employment tax (Social Security and Medicare) and state and local tax as well.

Companies provide employees with either one uniform withholding method or several options to pay the taxes on their restricted stock units. They may offer:

Net-settlement: a company “holds back” shares to cover RSU taxes and then the company pays the tax from its own cash reserve. This is the most common practice.
Pay cash: an employee receives all shares and covers the RSU taxes out of their own pocket. This is a riskier strategy than net-settlement, as it results simultaneously in a more concentrated equity allocation and lower cash balance (less money to pay the taxes).
Sell to cover: an employee sells the shares needed to cover the income tax burden on their own. This method provides no real advantage over net-settlement and places the additional burden of selling the shares on the employee.

When an employee ultimately sells their vested shares, hopefully based on their well-constructed RSU selling strategy, they will pay capital gains tax on any appreciation over the market price of the shares on the vesting date. The sales proceeds will be taxed at the more favorable long-term capital gains rate if the shares are held longer than one year after vesting. (4)

What is an RSU? | Restricted Stock Units Stock Options | rsu taxed — An example timeline of an RSU strategy shows hypothetical stock price at vesting

Taxation of Restricted Stock Units Example:

Here’s an example of an RSU selling strategy: An employee is granted 750 RSUs on January 1, 2018. The market price of the stock at the time of grant is $10 and the RSUs vest pro-rata over three years:

Taxation of Restricted Stock Units : RSU strategy and RSU taxed

RSUs and Stock Options — **Taxation of Restricted Stock Units** – RSU stock prices may go up or down. This is hypothetical.

Each increment is taxable on its vesting date as ordinary income. The total ordinary income paid over the three years is $11,500.

The employee then sells all 750 shares of stock three years after the last shares vest.

Taxation of Restricted Stock Units is dependent on price and timing of sale

The employee held each share of his RSU stock options for more than one year, so the gain is treated as long-term. The employee’s long-term capital gain is $11,000 ($22,500 less $11,500) to be reported on Schedule D of their U.S. individual tax return.

RSU Strategy | What Are the Risks of Holding RSUs?

Utilized correctly, restricted stock units/restricted stock shares can be a wonderful complement to a traditional compensation package and can contribute substantially to an employee’s net worth. (5) This can be, however, a double-edged sword.

The overlying risk is that an employee can have too much of their net worth concentrated in one individual stock and one individual company.

Restricted Stock Units | RSU strategy — RSU strategy and RSU taxed – You can have too much vested interest in one company with restricted stock units.

Let’s explore a scenario:

Jim has a net worth of $200,000, not including 2,000 shares of RSUs with his employer, Snap Inc. On January 1, 2019, 100% of Jim’s 2,000 RSUs vest at $50 per share.

Great news! Jim’s net worth, on paper, has now increased by $100,000 overnight. Jim’s overall net worth is now $300,000.

Jim decides to keep all his shares in Snap Inc. with the belief the stock price will continue to go up.

He also sees his colleagues choosing to hold most of their shares, and fears that if Snap Inc.’s price soars, he will have missed out and his colleagues will all become wealthier than him.

On July 1, 2019, Snap Inc. releases a weak earnings report and the share price drops to $20. Jim’s net worth is now $240,000, down 20% from January 1.

Even worse, Jim paid taxes at his ordinary rate on the original share value of $100,000 when the shares are now only worth $40,000.

And finally, because Jim has a significant portion of his net worth in the company he works for, he faces an additional and potentially catastrophic risk. What if Snap Inc. runs into serious financial struggles and he loses his job? Not only will Jim’s net worth plunge from further declines in Snap Inc.’s share price, he also will now have lost his primary source of income.

You may see Jim as foolish, but his predicament is a common one. We often see employees dealing with the hesitation to sell the shares for reasons that can be more emotional than rational.

How Can I Most Effectively Plan for Restricted Stock Units, RSUs?

We recommend you discuss how to effectively plan for RSU shares with your financial advisor to ensure a decision is not made in a vacuum, but rather in the broader spectrum of your entire financial picture. Of course, we encourage collaboration with your tax advisor to determine the optimal strategy from a tax perspective as well.

In reality, when RSUs vest, you may be better off by immediately (or over a short-term schedule) selling a sizeable portion of the vested units and using the proceeds to add to or build a diversified investment portfolio.

Regardless, before you make any decisions, it can be helpful to explore the following questions:

How much of your overall wealth is tied up in RSUs?
Is your company growing quickly or slowly?
What is your current tax situation? Is it better to wait more than one year after the shares vest to sell them to receive the more favorable long-term capital gains tax treatment?
How long do you plan to be with the company?
What is your tolerance for risk?
If the market value of the stock was instead received in the form of a cash bonus, how much of this would you invest in the company stock?

How can we help with your RSU and stock options?

While we at Towerpoint Wealth continue to believe in the importance of a diversified portfolio, we also understand every individual situation is unique, what growing net worth means to each individual is different, and understand emotions can play a significant albeit oftentimes problematic role in making sound financial decisions. This is especially the case for RSUs. If you would like to speak further about what is an RSU vs stock options, or need an RSU strategy (or have questions about any nontraditional compensation for that matter), I encourage you to call, 916-405-9166, or email Steve Pitchford (Certified Financial Planner) email spitchford@towerpointwealth.com.

Learn more about Maximize stock compensation and What are RSUs?

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(1) While RSUs hold no automatic dividend rights, companies may choose to issue dividend equivalents. For example, when a company pays cash dividends to common stock holders, RSUs can be credited dividends for the same amount. These credits may ultimately be used to pay the taxes due when RSUs vest or can simply be paid out in cash.

(2) RSU strategy – Stock Options can either be Incentive Stock Options (ISOs) or Nonqualified Stock Options (NQOs). They are treated differently for tax purposes.

(3) When received, dividend equivalents are subject to the same tax rules as RSUs.

(4) Important to note that the shares must be held more than one year for long-term capital gains treatment. If sold exactly one year from the vesting date, they will be taxed at the higher short-term capital gains.

(5) Net worth means the total value of all of an individual’s assets less their liabilities.

Towerpoint Wealth, LLC is a Registered Investment Adviser. This material is solely for informational purposes. Advisory services are only offered to clients or prospective clients where Towerpoint Wealth, LLC and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Towerpoint Wealth, LLC unless a client service agreement is in place.

What are RSUs taxation of restricted stock units explained

Towerpoint Wealth April 8, 2022 No Comments

How Restricted Stock Units Work | What are RSUs? | Video 04.08.2022

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.

Download Towerpoint Wealth white paper on RSUs and stock options

Learn more about Restricted Stock Units

Employee Stock Purchase Plan One Minute Tax Tips

Matt Regan April 21, 2021 No Comments

Employee Stock Purchase Plan 04.21.2021

What is an Employee Stock Purchase Plan?

Employee Stock Purchase Plan | If you are an employee of a publicly traded company, it most likely offers an employee stock purchase plan, or ESPP for short (also sometimes called a section 423 plan). These are excellent plans to take advantage of, as they allow employees to purchase company stock at a discount. However, what most people do not fully understand are the tax consequences of selling the stock.

With an ESPP, an employee is not taxed at the time they purchase shares, but instead only when they sell. As you may expect, the tax consequences of the sale will be different, depending specifically on how long the employee has held the shares. This holding period will determine if the sale is a “qualifying disposition” or “disqualifying disposition.”

Oftentimes, Employee Stock Purchase Plans allow employees to use after-tax payroll deductions to purchase company stock at a discount, which can be as high as 15% off the actual market price of the stock. However, what most people do not fully understand are the tax consequences of selling the stock acquired through these plans.

Taxation rules of ESPPs

Understanding taxation rules associated with ESPPs means you have an understanding of the importance of a “disposition strategy” that will produce the best economic result for you. With an ESPP, or qualified Section 423 plan, as we’ve said, you are not taxed at the time the shares are purchased, but instead only when you sell.

Employees can generally sell shares at any time, which is great if you have immediate cash needs, or want to reinvest the money into other assets. However, the tax consequences of the sale depend specifically on how long you have held the shares. This holding period will determine if the sale is a “qualifying disposition” or “disqualifying disposition,” which governs how much of the gain will be taxed at capital gains rates, or at less favorable ordinary income rates.

A qualifying disposition occurs when you sell your shares after holding them for at least one year from the purchase date and at least two years from the offering date. The rules say that you will pay ordinary income tax on the lesser of either 1) The discount offered based on the offering date price, or 2) the gain between the actual purchase price and the final sale price. The remainder of the gain, if there is one, will be taxed at the more favorable long-term capital gains rate.

If you don’t meet the holding period requirements for a qualifying disposition, then by default you end up with a disqualifying disposition. You will pay “regular” ordinary income tax on the difference between the actual purchase price and the purchase date market price, and you’ll pay capital gain tax rates on the difference between the purchase date price and the final sales price. It’s a little complicated, we know.

As you can see, it is incredibly important you understand the ESPP tax rules and how they can impact the amount of money you end up keeping in your pocket, if and when you decide to sell any shares you own in your section 423 plan.

Feel free to contact Towerpoint Wealth on LinkedIn, Facebook, or Instagram to discuss a disposition strategy that is best for you given your circumstances and financial goals. What are the taxation rules associated with Employee Stock Purchase Plans—ESPPs—and can you be sure you’re minimizing taxes? It’s important to have a disposition strategy that will produce the best economic result for you.

Towerpoint Wealth February 15, 2021 No Comments

Is There a Vax to Protect Your Portfolio From Tax?

A 2016 survey of 1,000 taxpayers, conducted by WalletHub, found that, if told they never had to pay income taxes again, 27% of respondents would brand themselves with a tattoo that says “IRS” and 11% would gladly drive to Chipotle every single day for three years to clean its toilets. You can’t make this stuff up!

And while there is credible evidence and research that suggests people actually like paying taxes (click HERE to read a Psychology Today article about this “phenomenon”), in our 23+ years helping clients properly build and protect their net worth and wealth, we have yet to encounter a single client, prospect, colleague, or friend who fits this category. While we may intellectually understand why we have to pay them, most of us seem to emotionally detest it.

At Towerpoint Wealth, we recognize (and embrace!) our bias in working with and helping our clients towards achieving the goal of growing and building their assets as intelligently and as efficiently as possible. Understanding there are a myriad of road blocks, speed bumps, and hazards to account for while on this journey, we also recognize and coach our clients to understand that there are two major, and unfortunate, “necessary evils” that stand in the way of accomplishing this goal:

Fees, costs, and expenses
Taxes

And while neither of these is completely avoidable, intelligently reducing the drag of either one directly helps your portfolio get better gas mileage. Below are two simple examples to illustrate that point:

To be clear, we have encountered those who let the “tax tail wag the dog” and seemingly focus more on tax avoidance than net-worth building; our preference will always be to help our clients maximize their after-tax wealth, which does pair with having a tax bill every year. However, it also pairs with being directly mindful about keeping your obligation to Uncle Sam to an absolute minimum whenever and wherever possible.

The 2020 tax season is right around the corner, and with it will come some inevitable surprises for those who didn’t properly plan, or who were ignorant of certain aspects of and/or changes to their global 2020 income tax situation. And understanding the interest, dividends, and capital gains that will soon be showing up on your 1099 forms, (all of which report taxable income to the IRS), we encourage you to use the resources found at the bottom of this newsletter to your advantage, and to contact us (click HERE) if you encounter any unwanted 2020 “tax surprises,” or feel you would benefit from a fresh perspective on how to leverage and maximize ideas and opportunities to make your portfolio, and your life, more tax efficient.

What’s Happening at TPW?

Our Wealth Advisor, Matt Regan, working hard as usual from home right now, along with little Mason and Stevie, his loyal friend!

Directly reflecting the firm’s culture, Towerpoint Wealth is a family both inside and outside the office, as our Partner, Wealth Advisor, Jonathan LaTurner, our Client Service Specialist, Michelle Venezia, our President, Joseph Eschleman, and our Director of Tax and Financial Planning, Steve Pitchford all enjoyed a fun day hanging out together and watching Super Bowl LV!

TPW Service Highlight – Tax-Managed Portfolio Management

In addition to investment expenses, income taxes are the second of the two necessary evils we face when helping you grow, and protect, your net worth and assets in the most effective and efficient way. Taxes can severely impact investment returns if not monitored, scrutinized, and controlled. And while we never let the “tax tail wag the dog,” at Towerpoint Wealth we do maintain a specific focus on helping our clients absolutely minimize the tax impact of their investments, portfolio, and overall financial decision-making.

Utilizing low-turnover mutual funds, ETFs, and separately-managed accounts, taxable versus tax-free bonds, strategic tax-loss harvesting, tax diversification, and the asset location strategies discussed in Steve Pitchford’s MoneySavage podcast featured below helps us help our clients significantly reduce the income taxes they pay on their investments.

Issuance of 2020 Charles Schwab 1099s

A brief but important reminder for our Towerpoint Wealth family of clients: Initial Form 1099 production is based on two different waves at Schwab, with the vast majority (85%+) produced in the second wave:

Chart of the Week

The population exodus from high-tax states like California, New York, and New Jersey is very real, as a migration to other, oftentimes lower-tax states happens when individuals do not feel they are getting enough value for the taxes they are paying.

Federal and state income taxes are unfortunately a necessary evil when working to grow and protect your net worth, but working to manage and minimize your “obligation” to the taxing authorities is one of Towerpoint Wealth’s core competencies. Click HERE to message us and learn more about specific strategies to *reduce* your income tax pain.

Trending Today

In addition to tax drag and Super Bowl schwag, a number of trending and notable events have occurred over the past few weeks:

As always, we sincerely value our relationships and partnerships with you, as well as your trust and confidence in us here at Towerpoint Wealth. We encourage you to reach out to us at any time (916-405-9140, info@towerpointwealth.com) with any questions, concerns, or needs you may have. The world continues to be an extremely complicated place, and we are here to help you properly plan for and make sense of it.

– Joseph, Jonathan, Steve, Lori, Nathan, Matt, and Michelle