Mastering Your RSUs

Introduction

For many employees, a major part of their compensation program is through Restricted Stock Units (RSUs).  For employees, the rules around these stock awards and the way they are taxed can be confusing.  There are a variety of ways that these programs can be administered, but we will focus on the most common programs (for public companies) in this post.  Please reach out to me or your CPA for specific advice on your circumstances.

Definitions:

Before we get into the mechanics of RSUs, let’s define a number of common terms that we will use in this article:

RSUs: Restricted Stock Units, which are equivalents of company stock that are awarded to employees

Grant: when your company gives you a certain number of RSUs with a vesting schedule upon which you will receive them, subject to certain terms and conditions (remaining an employee of the company is typically the main item).

Vesting: the time when restrictions are lifted on the RSUs and shares are transferred to the employee.  This is also called a “lapse” to represent the lapse of the restrictions.    

Ordinary Income: income earned from your salary as opposed to capital gains (there are other sources of ordinary income – rents, royalties, interest, etc. that are beyond the scope of this discussion)

Capital Gains: income received from the increase of value of an asset (your company stock, in this example).  Gains from assets held longer than one year are taxed at favorable rates compared to ordinary income.  Assets held less than one year are taxed at ordinary income rates.

Capital Losses: if an asset loses value after you acquire it, this is a capital loss.  Capital Losses may be used to offset Capital Gains, and any excess can be used to reduce ordinary income by up to $3000, with the remainder to be carried over for use in future tax years.

Cost Basis: the original or purchase price of an asset, including any adjustments.  It is used to calculate your capital gain (or loss) when you sell the asset. 

RSU Grants

As part of your compensation package at many companies, you may receive RSU grants.  These are denominated in dollars, and then are translated into equivalent shares of stock.  In practice, here’s how this might play out with a fictional person and company.  Lisa receives an offer to join Nexus Intelligence Systems on March 1, 2019.  As part of her offer, she receives RSUs worth $150k that vest yearly over 4 years.  Nexus Intelligence Systems (NXIS) is trading at $125 per share when she accepts her offer.  She stays with this company for 5 years and is granted additional RSUs on her hiring anniversary each year.

Grant DateGrant AmountShare PriceShares Granted
3/1/2019$150,000$1251200
3/1/2020$175,000$1751000
3/1/2021$160,000$200800
3/1/2022$250,000$1002500
3/1/2023$180,000$1501200

Looking at the chart above, we can see that the number of shares granted is the Grant Amount divided by the Share Price.  Each of these awards vests annually over 4 years.  She will start to vest her first award on 3/1/2020, when she will receive 25% of that initial grant (300 shares).  The following year, she will receive the second 25% of her 2019 grant, plus 25% of her 2020 grant.  After 4 years with the company, she will vest 4 separate grants each year. Vesting schedules of companies may vary, but 4 years is common.  Some companies will vest shares more frequently than once per year, but we will use the annual example in this exercise for simplicity’s sake.

As the share price fluctuates, so does the value of the award.  Awards that were granted at lower share prices can have significant increases in value as they vest over 4 years.  Keep in mind that stocks do not only move up! An award can be worth significantly less as it vests.  This is something to keep in mind as you begin to accumulate shares in your company via the RSU program.

As Lisa reaches her 5th year at the company, she is now vesting 4 separate awards each year.  This is a powerful incentive for her to stick around at her company!

Vesting and Taxes

When you are granted RSUs, it is a non-event* in terms of income taxes.  When your RSUs vest, however, that is considered a taxable event, as it is compensation paid to you (in the form of stock) by your company.  What you do next will determine whether or not you have additional tax liability.

Let’s consider a few scenarios with our friend Lisa at Nexus Intelligence Systems. 

Lisa sells all of her shares at each vesting date.

In this situation, Lisa will owe her normal ordinary income taxes due to the stock vesting.  She sells her shares as soon as they are granted to her and keeps the cash.  She’ll see the compensation that she earned from the vesting on her W-2 and that will be the end of her tax obligations.  There will be no capital gain or loss, as she disposed of her shares on the same day that she received them.

Lisa holds onto all of her shares as they vest, and after 5 years decides to sell some of them.

Remember, regardless of whether she sells or holds her stock, the vesting itself is taxable as ordinary income.  Lisa has paid those income taxes in each of the years that she has vested, but she has chosen to hold the stock. Since she has held the stock past the vesting date, she has the potential for it to appreciate in price, which would lead to capital gains taxes.

Now, it’s June of 2023, and NXIS is trading at $160, and Lisa has decided that she has too much of her net worth in her employer’s stock and wants to diversify.  She uses the chart below to determine which shares she wants to sell.

SharesYear VestedYear GrantedCost BasisCurrent ValueGain/ Loss
30020202019$52,500$48,000-$4,500
30020212019$60,000$48,000-$12,000
25020212020$50,000$40,000-$10,000
30020222019$30,000$48,000$18,000
25020222020$25,000$40,000$15,000
20020222021$20,000$32,000$12,000
30020232019$45,000$48,000$3,000
25020232020$37,500$40,000$2,500
20020232021$30,000$32,000$2,000
62520232022$93,750$100,000$6,250
Total:$476,000$32,250

You’ll note a Cost Basis and a Gain/Loss column in her holdings.  The Cost Basis is determined by the stock price at the time that Lisa received the shares (when they vested, not when they were granted).  The Current Value is what those shares are worth today, and the Gain/Loss represents how much the difference is between that Cost Basis and the Current Value.  You’ll see that Lisa currently holds $476,000 of NXIS, and her total unrealized gains are $32,250. 

If Lisa is only selling some of her shares, then she will want to carefully select which ones she wants to sell.  If she doesn’t pay close attention, she could end up paying more in taxes than she needs to.  Let’s take a look at a couple of potential sales and their tax consequences.  If she sold everything, she would realize short-term capital gains (taxable at ordinary income rates) of $13,750 from the stock that vested in March 2023 (since it increased in value from $150/share to $160/share from March until June) and then she would have another $18,500 in long-term capital gains, since the other shares were held for more than a year.

If Lisa doesn’t need all of that cash, and is looking to minimize her taxes, she could sell the shares that currently are showing a loss.  Those three sets of shares total to $26,500 in losses.  She could then sell the 2022 vestings of her 2020 and 2021 awards, which total $27,000 in gains.  With the two offsetting, she now only owes taxes on $500 of long-term capital gains while freeing up $208,000 in cash.  She has now reduced her exposure to NXIS by almost half, and has paid hardly any taxes on it. 

Gotchas

Many employees who have large RSU awards vesting will find that they have under-withheld on their taxes and end up owing taxes and penalties to the IRS.  It’s important to plan for this situation by either adjusting your withholding from your employer, or making quarterly estimated tax payments to ensure that you don’t have a large tax liability when filing your tax return.

Be sure to discuss with your CPA or financial planner before moving forward with any RSU strategy.  You don’t want to run into potential tax consequences once it’s too late.  In the example above, Lisa has waited for a few months past her last vesting date to make her stock sales.  If she were selling for a capital loss around the same time she was receiving shares from a vesting event, she would have to be careful to not run afoul of the wash sale rule, which disallows losses if you purchase the same (or substantially similar) security within 30 days before or after the loss that you are taking. 

RSUs are an amazing perk, but they do often encourage employees to concentrate too much of their net worth in their employer’s stock.  This can leave you in a quandary if something happens to your company that damages the stock price or your employment.  You don’t want to be caught in a situation where you are dependent upon one company for your income and your life savings!  From a risk management perspective, not holding too much of your net worth in one company is a worthy goal – even more so if that one company also is responsible for your paychecks.

*If you have a Restricted Stock Award (RSA) or are at a private (pre-IPO) company, there are a number of other options that you may have that are beyond the scope of this article.  Reach out to me or your CPA to get specific information about your situation.