When reviewing your compensation package, it’s important to consider any stock plans that your company may offer. There are many different types of plans, and depending on the plan and how the company stock performs in general, these plans can make up a significant portion of your total compensation.
One of the more common forms of stock compensation is restricted stock units (RSUs). These are company shares that are granted at one time, but you actually don’t receive the shares until they vest, usually in chunks, over the course of a few years. But just like any stock plan, how to manage it and the tax considerations vary.
Here’s what you should know about how RSUs work, the tax implications, and best practices for managing your plan.
What Are RSUs?
RSUs are shares of a company that are granted at one time but vest over a series of years. The grant date is mostly meaningless; it’s simply the date when the company gives you a schedule of how many shares you can expect to vest and when. The vesting date is the actual date you receive a portion of the granted shares and can keep or sell them. If you leave the company before the vest date or are terminated for another reason, you generally do not get to keep any unvested shares.
Example: Mary works for XYZ company and is granted 400 shares that will vest on January 1 over the next four years. On January 1, 2024, she receives 100 shares. On the next January 1, she receives another 100 shares. She leaves the company on June 30, 2025, and by doing so, she forfeits the remaining 200 shares that have not vested.
Like other stock plans, there may be some restrictions on selling stock during certain times of the year. These typically revolve around earnings dates or other important company announcements. Besides those dates, once your shares are vested, you can sell them at any time.
Since you don’t yet own unvested shares, you aren’t necessarily entitled to any dividends the company stock pays between the grant and vest dates. Some plans do pay what is called a “dividend equivalent” that will either give you cash or add additional shares when your unvested shares vest. Since dividends can be a significant portion of a stock’s total return, having a plan that pays dividend equivalents can be significantly more valuable than one that does not, assuming the company stock pays a dividend at all.
How Are RSUs Taxed?
As far as stock plans go, the taxation of RSUs is somewhat more simple than other plans. Essentially, the value of the vested shares counts as income and you are taxed on the value of the stock received at vesting. Before vesting, no taxes are due because you do not own the shares yet. If you leave and lose the unvested shares, no tax is due because you never received the shares. Being granted shares is irrelevant for tax purposes. Only vested shares count.
Example: Mike has an RSU plan where 100 shares of ABC company vest on June 30 of each year. On June 30, 2023, ABC stock is trading at $50 a share. Mike is taxed on the $5,000 value of the stock received at vesting (100 * $50). On June 30, 2024, the stock increased to $75 at vesting. So, his taxable income in 2024 is $7,500 from the vested stock.
The value of the stock at vesting determines the price you “paid” for the stock. This is important for any subsequent sale. If you sell the stock for more than it vested for you must also report a capital gain. If you sell it for less, you will report a capital loss on the difference. Like owning regular stock, if you hold the stock for more than one year, the gain or loss is considered long-term term, and short if held for less than a year. The holding period is based on the vest date, not when the shares were granted. Also, now that you own the stock, any dividends you receive from vested stock are included as income for that year.
What can be nice about RSU plans, compared with other stock plans, is that generally, tax is withheld upon vesting. This is often done by selling, or withholding, some of the shares immediately upon vesting to go toward taxes. The downside to this automatic withholding is that it is often done at a different rate than your usual withholding. This can mean either too much or too little tax is withheld from the vested stock. If you have an RSU plan, it often makes sense to review the withholding annually to determine whether too much or too little tax is being withheld so you can make adjustments and are not surprised at tax time.
While some aspects of RSU plans are easier for tax reporting, other parts can be a little more complicated. When you sell shares, because of how the brokerage company receives and reports the information, the actual basis (purchase/vest price of the stock) can be off. Often, the basis on RSUs shows low on the tax form 1099-B that is used to report stock sales. The brokerage company will often provide a supplemental tax form that shows the basis adjustment to the stock to report the actual vest price correctly. Usually, if you just use what is shown on the 1099-B, you will be overpaying taxes by reporting a larger gain than you actually sold for!
Depending on your level of comfort in preparing your own taxes and reading these tax forms, it may make sense to outsource your tax preparation to a qualified tax preparer if you have an RSU plan. Depending on the amount of shares you receive, the time savings, tax savings, and peace of mind may be well worth an accountant’s fee.
Best Practices for Managing RSUs
The best way to think about RSUs is as a cash bonus, but with an extra step. Yes, you are receiving company stock instead of cash, but you are taxed on the exact amount you receive right away. Since you’re taxed on the value of the stock, we find it makes the most sense to sell the stock as soon as you can. Now you have the cash, just like a normal bonus. Since you sold as soon as possible, there should also be very little gain or loss on the sale itself since you sold it so close to receiving it.
We find that holding the stock from RSUs is too risky, especially since there are no real additional tax benefits compared with other types of stock plans. We generally recommend avoiding holding too much stock in the company you work for. This is because not only is holding a large portion of one stock risky and not diversified, but this under-diversification is amplified because your salary and benefits are tied to your employer too. If your company is not doing well, not only is the stock likely to be negatively impacted, but you may be at risk of a layoff or a reduction in certain performance-based incentives.
When you receive a cash bonus, you wouldn’t go out and buy your company stock with it. So, when you receive vested RSUs, why keep the stock when you’re already taxed on it and there are significant risks to holding it? Also, since RSUs are generally distributed in grants, and these grants tend to be something companies offer on a regular basis, you’re still participating in the gains of the stock as long as you stay employed with the company. If the stock does well between your previous vest and your next one, the amount of your “bonus” will be larger because the stock has performed well. Since a grant is often made up of multiple vesting years, as long as you remain employed with the company, you are “invested” in the stock performance without actually holding the stock. Selling the stock as soon as it vests not only helps diversify your investments but also avoids a situation where you sell the stock later at a loss but are taxed at a higher amount.
An analogy that we like to use for managing RSUs is a conveyor belt. The grants you receive are the raw inputs going onto the assembly line. Between the grant and the next vest, the “product” (your stock) is being assembled. As soon as it vests, the stock is “shipped” (sold), and the cash can be redeployed in the business (you). This process is repeated as long as you have granted shares that have not vested yet.
One important thing to remember when managing RSU plans is that if you leave the company, you generally forfeit any unvested shares. Since stock plans, including RSUs, can make up a significant portion of your total compensation, it often makes sense to be strategic when deciding to leave a company. Just like with a normal cash bonus, if you know when it is coming, it can often be worth sticking out a job to get the bonus and then leave afterward. The benefit of RSUs is that you know the exact date each grant vests. Being strategic about when you decide to leave can allow you to part with substantially more money if you leave after a vest date rather than before.
RSUs can be an excellent part of a compensation package, depending on the size of the grants and how well the stock performs. Out of many of the types of stock plans available, RSUs tend to be one of the simpler ones to manage. Because of how RSUs are taxed, and the additional risk of holding stock in the company you work for, it often makes sense to sell the shares as soon as they vest. It’s best to consider RSUs as a cash bonus that requires the extra step of selling the stock first.
If you leave a company before an RSU grant vests, you forfeit those shares. Deciding to resign around the time RSUs vest is common. Of course, retiring from a company or taking another opportunity is a big decision that has not only financial considerations but emotional and personal ones as well. Like everything in finance, the decisions we make should be ones that move us closer to our personal and financial goals. If you need help reviewing your stock plans or financial situation, please reach out to our team.
Disclaimer/Author(s) Bio: This is not to be considered investment, tax, or financial advice. Please review your personal situation with your tax and/or financial advisor. Milestone Financial Planning, LLC, (Milestone), a fee-only financial planning firm and registered investment advisor in Bedford, NH. Milestone works with clients on a long-term, ongoing basis. Our fees are based on the assets that we manage and may include an annual financial planning subscription fee. Clients receive financial planning, tax planning, retirement planning, and investment management services, and have unlimited access to our advisors. We receive no commissions or referral fees. We put our client’s interests first. If you need assistance with your investments or financial planning, please reach out to one of our fee-only advisors. Advisory services are only offered to clients or prospective clients where Milestone and its representatives are properly licensed or exempt from licensure.