Restricted stock units are often offered as part of a compensation package to attract and retain key employees. They are restricted in that certain requirements must be met before the employee can obtain full ownership rights to the value of the units.
Receiving your RSUs is usually contingent on staying employed with the company for a certain period of time, which is why the units come with a vesting schedule. Before they vest, RSUs are simply a future promise.
Understanding What Happens Immediately After RSUs Vest
Vesting schedules for RSUs dictate how and when the restricted stock units become the property of the employee.
A vesting schedule might, for example, state that 25% of the RSUs vest each year for 4 years. Once vested, RSUs shift from a future promise to actual property of the recipient.
This “property” most often comes in shares of company stock, but RSUs may also be paid out via cash compensation. Your plan document should tell you more about exactly how your RSUS are set up.
When RSUs vest, that triggers a taxable event. The value of the vested units will be taxed as ordinary income, subject to both Social Security and Medicare tax.
Your tax obligation here is commonly handled via an automated share withholding when the shares vest. Your company will withhold a number of shares required to cover the tax cost).
(Keep in mind that the amount of tax that’s withheld is often the statutory withholding requirements — but it might not be enough to cover your actual tax bill. Ensuring you know if you generated enough cash to cover your tax liability when your RSUs vest is one of many reasons to consider working with a financial planner or tax professional with expertise in stock options.)
Once Your Shares Are Yours… Should You Keep or Sell Your Restricted Stock Units?
Once your RSUs vest, they’re yours. You have full ownership rights to the shares that are left after the share withholding has occurred. At this point, you have a decision to make: should you keep your shares, or sell them?
While there may not be a single answer to address every need, we can evaluate the options by exploring the factors that can influence what makes a decision the right one for your situation.
One way to think about restricted stock units is to consider the vested value as compensation income for services rendered. Compensation income is earned income paid to you for successfully doing your job.
If you think about the value of restricted stock units as compensation for your work, their value should logically be the same as what you receive in your weekly, bi-weekly, or monthly paycheck. And in fact, RSUs are taxed the same as your regular paycheck, too.
The major difference is how each type of compensation is paid out to you. Your paycheck is given to you as cash that gets deposited into your bank account. That’s money you can use to pay bills, save, or spend.
Vested restricted stock units paid as shares, however, is company stock… meaning the value is on paper and not realized until you sell shares.
Know the Taxability of RSUs to Help You Decide What to Do Once Your Units Vest
Assuming you are not in a lock-up or blackout period (or facing any other restrictions), you may be able to sell the shares you received from your RSUs right away. Doing so allows you to convert the value of company stock into cash, just like your paycheck.
To better understand the right time to sell your restricted stock units, let’s explore how your RSUs are taxed when they vest and when you sell the shares:
- Your RSUs vest, and their value is reported as ordinary income
- When your RSUs vest, the full value of the vested units is taxed as ordinary income and reported on your year-end W-2.
- Income tax is often withheld at a statutory rate (22% in 2020), and other withholdings are made for payroll and other taxes. Your company will usually retain a certain number of units equal to the value of the tax liability to manage that withholding.
- The after-tax value of the vested units is then deposited into a brokerage account as shares of company stock (assuming the units settle as shares). The cost basis of the owned shares is equal to the fair market value per share on the vest date (the amount taxed as ordinary income), and your purchase date of the stock is the date the shares vest.
- You Sell Your Company Stock in the Brokerage Account
- If you sell your shares, you report a capital gain or loss. The proceeds of the sale are deposited into your brokerage account, and the transaction is reported on a 1099-B tax statement at the end of the year.
If you sell your RSU shares immediately after they are deposited into your brokerage account, the tax impact of a sale will likely be minimal.
For example, let’s assume that your shares are deposited with at cost basis equal to the vesting date FMV or $50 per share. Let’s also assume that you sell the shares right away when the FMV is still $50 per share.
This is reportable tax event, but since the gain is $0 (your cost basis equals the sale price), you don’t owe additional taxes when you sell your restricted stock units.
Why You Might Want to Sell Your Restricted Stock Unit Shares Right Away
As you can see, it is possible that you experience no tax impact from selling shares. This is a good reason to consider selling right away, and transferring the paper value of the shares into actual cash you can use.
The next factor to consider when determining the best time to sell is whether you even want to own company stock. If you accept the suggestion that your RSUs are compensation income for services rendered, why not take that compensation as cash?
To illustrate this, let’s consider the following question: If I offered to give you tens of thousands of dollars in cash right now, would you use that money and go buy company stock? Or would you use it for another need?
If you’d take the cash, that’s a very good reason to consider selling your shares immediately to turn a paper value in to actual cash you can use.
Using hypothetical numbers to illustrate the impact of this question, let’s assume that you have the following shares of vesting RSUs.
- RSUs Vesting: 1,000
- FMV of Stock: $50
- RSU Value: $50,000
If we assume that the value will be settled in shares after a 22% statutory withholding (we’ll assume there are no other taxes withheld to simplify the example), the value to be received after tax is:
- Value of Vested Units: $50,000
- Tax Withholding: $50,000 x 22% = $11,000
- After-Tax Value: $39,000
- Shares Deposited: 780
In this example, you will receive 780 shares of stock. So again: if I were to give you a check for $39,000, how much of that money would you use to buy 780 shares of company stock?
If the answer is none of it, it may make a strong argument to sell your RSUs right away.
Integrating Restricted Stock Units and Other Equity Compensation
If you have restricted stock units, it is possible that you have other types of equity compensation too. If you do, it may make for a more complicated situation when evaluating what of your various shares to sell.
Each type of equity compensation (incentive stock options, non-qualified stock options, employee stock purchase plan) has its own rules for when you may be able to do certain things, and what the tax impact of your decisions may be.
While beyond the scope of this article, its safe to assume that more detailed analysis should be integrated into your financial plan if you have more than one type of equity compensation because of the differences in taxability.
What to Do Now with Your Restricted Stock Units
If you have restricted stock units, pay attention to when the shares vest, what the value is, and how you receive that value (i.e. as cash or as company shares of stock). If you receive the value as shares of stock, you need to determine what’s in your best interest: keeping them, or selling the shares.
If you think you’d rather sell the shares and use the proceeds for other needs, it’s probably a no-brainer. Consider selling your shares immediately. The shares have already been taxed and you can sell them quickly with little to no tax impact (assuming the current price is near the vested price).
Furthermore, the immediate sale of restricted stock units can also help you diversify after from single stock risk or an over-concentrated position on company stock. This is an important consideration for anyone who wants to reduce risk in their investment portfolio.
But as with every question in financial planning, there’s no one-size-fits-all answer. Make sure you fully evaluate your personal situation, your goals and objectives, and your willingness to take investment risk prior to implementing any decision to buy or sell shares of company stock you acquired after your RSUs vested.
The content herein is for illustrative purposes only and does not attempt to predict actual results of any particular investment. Diversification does not guarantee a profit or protect against a loss. None of the information in this document should be considered as tax advice. You should consult your tax advisor for information concerning your individual situation. Tax services are not offered through, or supervised by, The Lincoln Investment Companies.