Restricted Stock Units (RSUs) are a form of equity-based compensation, where employers grant employees company stocks. These stocks are “restricted”, meaning that employees will only receive the stocks if they meet certain requirements. For example, RSUs will become vested a year after the date of grant. Once the requirement is met, the RSU’s become the sole property of the employees and transferred to their brokerage account.
What are the tax implications of RSUs?
RSU’s are taxable and subject to ordinary income taxes, as they are considered earned income. RSUs are called supplemental income, but treated as salaries or wages for tax purposes. There are a few important dates to keep in mind for RSU tax purposes:
1) Grant Date: On this date, the employer grants or issues the employee a certain number of RSUs, along with the terms. Being granted an RSU is like being promised that you will receive a certain number of stocks of the company on the vesting date. There are no taxes due on RSUs when they are granted.
2) Vesting Date: On this date, the RSU restrictions are removed and the employer officially transfers the stocks to the employee, and the employee becomes the unrestricted owner of the stocks. Vesting is a taxable event and the employer withholds both Federal and state taxes on the date of vesting. The amount of income or compensation assigned to the employee is the market value of the stocks on the date of vesting and included on the W2’s.
Employers generally offer two methods of withholding taxes on vested RSUs.
a) Share withholding or “cancel-to-cover”: The employer withholds part of the vested stocks to cover for Federal (IRS) and state taxes. For example:
# of stocks vested 10
Market value of the 10 stocks $1,000
Federal required withholding 22%
State withholding 8%
The employer transfers only 7 of the 10 shares vested to the employee’s brokerage account. They withhold the 3 stocks to cover the Federal and state taxes.
b) Sell-to-Cover: The employer initially transfers all 10 shares to the employee’s brokerage account, and then sells 3 shares to pay the Federal ad state taxes. The employee will be left with 7 shares in their brokerage account.
3) Post Vesting Date: After the vesting date, RSUs are treated like any other stocks held by the employee. They are no longer RSUs, but shares held in the employee’s brokerage account. If the employee sell the stocks after the vesting date, they will be taxed on the difference between the stock’s price on the vesting date (tax basis) and the stock’s price on the date you sell it. The result will be a capital gain or capital loss.
4) Other Tax Considerations: The statutory federal tax withholding rate on RSU’s is 22%. If the employee’s marginal tax rate is higher, say 37%, then there will be a 15% under-withholding of federal taxes. As a result, the employee will owe taxes at the end of the year when a tax return is filed. One way to avoid this is to elect (with the employer) to be taxed at the higher rate of 37%.
We work with many professionals and executives who have RSU arrangements and plan to ensure their taxes are minimized.
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