RSUs Explained
What are RSUs? RSUs are restricted stock units that are a form of compensation for employees. They are issued to employees through a vesting schedule upon remaining with the company for a specified period or reaching a required performance milestone. Restricted stock gives employees ownership in the company once they vest.
What is vesting? Let’s use an illustration to explain.
For example, you have a grant of 20,000 shares of restricted stock. The vesting amount is 5,000 RSUs per year, which means you own an additional 5,000 shares each year. This year, 5,000 shares vested when the market price was $15. As a result, you have $75,000 of additional compensation for the year.
More Money, More Problems
$75,000 of free money! But hold on, you have to pay taxes on the RSUs because they are a form of compensation. Taxes on this compensation are usually withheld at vesting. Your company will apply a method to determine the fair market value (FMV) of the shares for this purpose. Some companies use the closing price on the vesting date, like the example above.
Withholding Taxes
Withholding taxes for RSUs are withheld at vesting. These taxes include federal income tax, Social Security tax, Medicare tax, and state and local income taxes, where applicable. For supplemental wages totaling up to $1 million during the calendar year, the federal withholding tax rate is 22%. If supplemental wages are above $1 million during a calendar year, the federal withholding rate is 37%.
If your income is over $89,075 (single filer) or $178,150 (married filing jointly) in 2022, you are in the 24% bracket (or higher). In this case, the 22% federal withholding rate is lower than the amount of taxes you owe. Speak with your tax professional prior to vesting about making estimated quarterly tax payments.
Withholding Methods
Companies offer choices for withholding taxes. Several withholding choices include net share settlement, sell to cover, or payment by check.
Net share settlement is a technique where shares are surrendered to cover the taxes. A number of companies do this automatically for employees and offer no other choices for withholding.
In sell to cover, a block of shares (for all employees) is sold for the taxes and employees’ accounts get the excess from the sale proceeds. Payment by check is exactly how it sounds. The employee writes a check for the payment of the taxes on the vest date.
RSU Tax Return Time Tips
RSU compensation is taxed in the same manner as your salary. When you complete your federal income tax return, Form 1040, for the year of vesting you include the RSUs in your gross income. This is a helpful hint in case you still haven’t filed your taxes!
Taxes on Restricted Stock After Vesting
Once the RSUs vest, you own the shares, and their cost basis is the market price on the vesting date. From the example above, $15 is your cost basis. When you sell the shares at a price higher than your cost basis, after owning them for more than one year, you will owe long term capital gains taxes. Those tax rates can be 0%, 15%, or 20% depending on your income. Assuming you sell at a price higher than your cost basis, prior to one year, your short term capital gains taxes will be the same as your ordinary income tax rate.
Questions to Ask About Your RSUs
- Should I continue to own the shares once they vest?
- Why are RSUs so complicated?
- What resources do I use to help me understand my RSUs?
- How do RSUs play in the achievement of my financial goals?
- What is my framework for making timely and profitable decisions with my RSUs?
- What tax planning strategies do I use with RSUs?
- How do I combine RSUs with other opportunities to achieve my financial goals?
If you have more questions, please free to set up a complimentary consultation.