In today’s competitive job market, where the top companies are competing for the top talent, employers use every tool at their disposal to attract and retain the best of the best. More and more often, these compensation packages go way beyond salary and factor in other employee benefits, such as top of the line health insurance plans, a 401(k) plan with a company match, and for those in the more senior roles, shares of company stock in the form of Restricted Stock Units.
What Are Restricted Stock Units?
One of the most common mechanisms for issuing this company stock is through Restricted Stock Units (RSUs). Restricted Stock Units are shares of company stock that are promised to an employee at some future date, with the hopes of keeping the employee with the company. This restriction is known as a vesting schedule. The RSUs will not transfer (vest) to the employee until a specific date in the future, a date which is specified at grant (“grant” is the date the employee is originally awarded the promise of the future shares). In more rare instances, RSUs will only vest once specific performance goals or milestones are met, but this is a less common way to grant shares to employees.
How Are Restricted Stock Units Valued?
Upon vesting, all of the shares the employee was promised on grant date (or a set percentage of the total shares, which would also specified on grant date) are considered taxable compensation to the employee and are reportable on their annual W-2 for the year. The value of the shares for tax purposes is based on the stock’s share price on the date that the shares vest. In addition to federal and state income taxes, Restricted Stock Units are also subject to social security and medicare taxes, better known as payroll tax.
How Are Restricted Stock Units Taxed?
Typically, once the first lot of granted shares vest, some of the shares are automatically sold on behalf of the employee to cover the estimated taxes due for federal, state, and payroll taxes, leaving the remainder of the shares for the employee to either sell immediately for cash or hold for future capital appreciation and preferential long-term capital gains treatment.
One of the downsides of RSUs as a mechanism for issuing shares to employees, is that they do not offer much in the way of flexibility. On the day the shares vest, some of the shares are sold automatically for taxes, and the rest are funneled to the employee to decide to keep or hold.
Here is an Example of How RSU’s Work:
Let’s assume an employee is granted 1,000 shares of company stock on 1/1/2019 (grant date), subject to 3 years of vesting restrictions, and vesting 50% in the first year, 25% in the second year, and 25% in the third year. This is a promise to the executive that, as long as they stay with the company, they will receive their shares of stock as follows:
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- 2019: Grant Date; No shares vest, promise is made for future shares.
- 2020: No shares vest.
- 2021: No shares vest.
- 2022: 50% of the 1,000 shares vest on 1/1/2022; executive granted 500 shares.
- 2023: 25% of the 1,000 shares vest on 1/1/2023; executive granted 250 shares.
- 2024: Remaining 25% of the 1,000 shares vest on 1/1/2024; executive granted remaining 250 shares.
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Tax wise, the employee can expect to receive about 60% of the shares that vest each year, once social security/medicare, and federal/state income taxes are withheld. Shares will automatically be sold on the employee’s behalf and remitted to the proper taxing authority to cover the estimated liability. The employee then has the ability to sell the shares that remain for the cash, or keep the shares that remain, with the goal of future capital appreciation.
Continuing with the above example, net of taxes the employee would receive 300 shares in 2022 and 150 shares in both 2023 and 2024.
As you can see, these RSUs are structured in such a way that they are front-loaded to give the employee higher compensation sooner rather than later, with a smaller amount of shares vesting in subsequent years. This is intentional to keep the employee interested with the hopes of having them remain with the company indefinitely.
Should You Keep Your Restricted Stock Units or Sell Them?
Keep in mind that there are many ways to structure the receipt of RSUs, both number of years to wait and percentage of shares to be received each year. Additionally, employees who receive RSUs are typically granted them each year, so that after an initial few years without receiving any shares, the employee gets at least one, but often times multiple, lots of RSUs vesting each year. This can add up to a lot of additional income over the years and make a dramatic impact on one’s overall financial plan and tax picture.
Deciding whether or not to keep your remaining shares and how they affect your overall financial plan can be difficult to analyze. This is one of the items we review and analyze for our clients (when applicable) on a regular basis, providing guidance on the best course of action to help them achieve their short and long term goals.
Matt Crisafulli, EA, CFP® is a Partner at ACap Advisors & Accountants, as well as a UCLA Alumnus. He is a Fee-Only CERTIFIED FINANCIAL PLANNER™ practitioner and an Enrolled Agent licensed by the IRS.
ACap Advisors & Accountants is a “Fee-Only” wealth management and full-service accounting firm headquartered in Los Angeles, specializing in helping doctors and healthcare professionals make sound financial decisions.
