Tax planning for RSUs differs greatly from the planning strategies that you should use for stock options. By understanding RSU tax and how RSUs differ, you can maximize the value of RSUs and prevent costly errors.
Here is how RSUs are taxed and how employers handle RSU plans and RSU withholding.
What Are RSUs?
RSUs are a commitment by a company to give the value of a defined number of that company’s shares in the future. Public companies often issue RSUs as an alternative to stock options. This is common in the tech industry with companies such as Facebook, Google, and Microsoft using them.
Typically, certain conditions need to be made before the holder of the RSUs can actually receive the value that has been promised. Settlement of RSUs can be issued as stock or the equivalent cash value of the company’s stock. If a recipient of RSUs receives stock, that employee then becomes a company shareholder.
When Do You Pay Taxes on RSUs?
When you receive an RSU, there is no immediate tax liability. Instead, you must pay income tax when the shares are delivered to you. This typically occurs at vesting. As a result, the vesting date is a key factor in tax planning for RSUs.
RSUs and Capital Gains Taxes
If you sell your stock after your RSUs are converted to shares of the company, you’ll be subject to capital gains tax as well. If you hold the stock for less than one year, your gain will be considered short term. You’ll be required to pay the ordinary income tax rate on your gains.
However, if you hold the stock for one year or longer, your gain will be considered a long-term gain, which means you can pay tax on your gains at the more favorable long-term capital gains rate.
How Does Vesting Work for RSUs?
There are several events that can trigger vesting. With time-based RSUs vesting automatically occurs after a certain amount of time has passed. Then on the vesting date, you will receive the stock.
However, some companies may opt to make vesting conditionally dependent on key performance goals. The company may require that the stock achieve a certain stock price or deliver a total shareholder return based on earnings-per-share targets.
At some startups, vesting depends on the how long the employee has been with the company. Vesting could also depend on a liquidity event, such as the company’s IPO.
How Do Employers Issue RSUs in Practice?
The administration of RSU plans varies from company to company. Here are RSU plan variables that you should be aware of when it comes to your employer.
Your Employer May Administer Withholding
Your employer may opt to withhold taxes based on the value of your shares. In some plans, companies withhold federal, state, local, and employment taxes. In fact, if a stock plan transaction results in taxable income, your company is required to withhold and remit the taxes due. Your RSU plan may allow for multiple tax withholding methods, such as the Net Shares, Sell Shares, Deposit Cash, and Pay cash.
It is very important that you check whether your employer is selling shares to cover taxes. The sold shares could cost you more in the long term than simply paying the required taxes with cash.
What Happens If I Relocate?
If you relocate to another state, make sure that you review the tax laws for that tax. Some states tax RSUs if you reside or work in the state during at least part of the vesting period, even if you’ve already moved out of the state once the award has vested.
What Happens If I Leave the Company?
Given that the employer controls the triggers for vesting, make sure that you find out what might happen if your employment with the company ends for both voluntary or involuntary reasons. An acquisition of your company may also affect your RSU award. If your company is acquired will the RSUs continue to vest and later convert into shares of the buyer, only partially vest, or be canceled altogether?
RSUs and Retirement
If you plan to retire from the company before vesting occurs, make sure that you understand how the plan will work. You may end up receiving the entire award or only a portion based on your service to the company leading up to your retirement date. RSUs can affect your cash flow during retirement and any strategies that you might want to use to shift your income in order to maximize your entitlements.
Where Do RSUs Show Up on Form W-2?
The amount that is reported in Box 14 on Form W-2 is the RSU amount. However, you should be aware that this amount is already included in Box 1 as wages. The RSU amount is included in your taxable wages when the RSUs vest. You can also ask your employer if you are unsure if Box 1 includes your RSU pre-tax amount.
When Should I Sell My RSUs?
Once your RSUs vest, you need to make a decision whether or not you want to sell it. If you are in need of some immediate income, selling your RSUs can help you cover your personal expenses. In addition, stock returns aren’t guaranteed. Employees often find themselves overweight in their company’s own stock when it comes to maintaining a diversified portfolio.
There are many considerations for RSUs that are unique to your own personal financial situation. If you have questions about RSU taxes and want to learn more about how to maximize the value RSUs, contact our offices today for further assistance.