What are Restricted Stock Units (RSUs)?

A Guide for Young Professionals

Restricted Stock Units (RSUs) are a popular form of equity compensation companies use to attract and retain top talent. They represent a promise to receive shares of company stock in the future, but only after certain conditions are met.

These conditions, known as vesting requirements, are typically time-based (e.g., working at the company for a specific number of years) or performance-based (e.g., achieving specific company goals).

Understanding how RSUs work, including vesting schedules, tax implications, and strategies for managing them, is essential for maximizing their value and achieving your financial goals. This guide will walk you through everything you need to know.

How RSUs Work

Vesting Schedules

Vesting is the process by which you earn the right to receive your RSU shares. It’s like a gradual ownership process. Most commonly, vesting occurs over a period of years, often with a specific percentage of shares vesting each year.

A common vesting schedule is 25% per year over four years. This means that if you’re granted 100 RSUs, you’ll earn 25 of those shares after the first year, another 25 after the second year, and so on.

Grant Date and Fair Market Value

The grant date is when your company awards you the RSUs. The fair market value (FMV) is the price of the company’s stock at that time. The FMV at vesting is crucial for calculating your income tax.

Settlement

Once your RSUs vest, the shares are typically delivered to you (this is called settlement). You then own those shares outright.

Tax Implications of RSUs

Tax at Vesting

When your RSUs vest, the fair market value of the shares at that time is considered ordinary income and is subject to income tax and payroll taxes (Social Security and Medicare).

Your company will withhold a portion of the shares to cover your estimated tax liability. This is important to avoid a large tax bill later.

Capital Gains Tax

When you eventually sell your vested shares, you may also have to pay capital gains tax on any increase in value after the vesting date.

The capital gains tax rate depends on how long you hold the shares after they vest. Short-term capital gains (less than one year) are taxed at your ordinary income tax rate. Long-term capital gains (more than one year) are taxed at a lower rate.

Short Term Capital Gains Tax Example

Emily has 100 RSUs vesting on February 15th, 2024. The fair market value (FMV) of the stock on the vesting date is $100 per share. She decides to sell all 100 shares the next day, February 16th, 2024, at a price of $102 per share.

1. Income Tax at Vesting:
Vesting Value: 100 shares x $100/share = $10,000
Taxable Income: This $10,000 is considered ordinary income.
Federal Income Tax: Assuming Emily’s federal income tax rate for this portion of her income is 22%, her federal income tax on the RSUs would be $10,000 x 0.22 = $2,200.
State and Local Income Tax: State and local income taxes vary significantly. It’s essential to check the specific requirements for your location. You can usually find this information on your state’s Department of Revenue website or by consulting with a tax professional.
Payroll Taxes: Emily will owe payroll taxes (Social Security and Medicare) on the $10,000. 6.2% for Social Security and 1.45% for Medicare, her payroll taxes would be $10,000 x (0.062 + 0.0145) = $765.
Total Taxes at Vesting: $2,200 (federal) + $765 (payroll) + [State and Local Taxes – Check Your Local Requirements] = $2,965 + [State and Local Taxes]

2. Capital Gains Tax:
Sale Price: 100 shares x $102/share = $10,200
Cost Basis: Emily’s cost basis is $100 per share.
Capital Gain: $10,200 (sale price) – $10,000 (cost basis) = $200
Short-Term Capital Gains Tax: This is a short-term capital gain. Using her 22% federal income tax rate, her federal capital gains tax would be $200 x 0.22 = $44.
State and Local Capital Gains Tax: Again, state and local taxes on capital gains vary. Check the specific requirements for your location.
Total Capital Gains Tax: $44 (federal) + [State and Local Taxes – Check Your Local Requirements] = $44 + [State and Local Taxes]

3. Total Tax Liability:
Emily’s total tax liability would be $2,965 (federal and payroll at vesting) + $44 (federal capital gains) + [State and Local Taxes – Check Your Local Requirements] = $3,009 + [State and Local Taxes]

Managing Your RSUs

Financial Planning

RSUs should be integrated into your overall financial plan. Consider your financial goals, risk tolerance, and time horizon.

Diversification

Don’t put all your eggs in one basket. Diversify your investments by selling some vested shares and reinvesting the proceeds in other assets.

When to Sell

Deciding when to sell your shares depends on several factors, including your financial goals, risk tolerance, and the company’s outlook.

Understand Your Plan

Carefully read your company’s RSU plan documents to understand the specific terms and conditions.

Seek Professional Advice

Consider consulting with a financial advisor for personalized guidance.

Common Mistakes to Avoid

Not understanding the tax implications.

Selling shares too early or too late.

Not diversifying.

Not understanding the vesting schedule.

Take Action Now

RSUs can be a valuable tool for building wealth.

By understanding how they work and taking a proactive approach to managing them, you can maximize their benefits and achieve your financial goals.