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RSU Taxes Explained: Tax Implications of Restricted Stock Units

RSU Taxes Explained: Tax Implications of Restricted Stock Units
Ryan McInnis
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RSUs (Restricted Stock Units) are a big part of compensation for many employees, especially in the tech industry. Unfortunately they can be a little complicated to understand. If you’re scratching your head wondering what exactly you own and how it’s taxed, you’re not alone. Here are the things you need to understand about restricted stock and its tax treatment, aka RSU taxes.

RSUs (Restricted Stock Units) are a big part of compensation for many employees, especially in the tech industry. Unfortunately they can be a little complicated to understand. If you’re scratching your head wondering what exactly you own and how it’s taxed, you’re not alone. Here are the things you need to understand about restricted stock and its tax treatment, aka RSU taxes.

What is a Restricted Stock?

Let’s start with the basics. Restricted stock is a stock typically given to an executive of a company. The stock is restricted because it is subject to certain conditions. For one, a recipient cannot sell or otherwise transfer ownership of the stock to another person until the restrictions lift. This happens over time through a vesting schedule.

Those receiving restricted stock must also meet certain conditions or risk forfeiting the stock. Executives who find themselves fired before they become vested in their stock. or those who fail to meet certain performance goals may lose their stock. Only when the executive meets the required set of conditions does full ownership of the restricted stock transfer to him. At this point, the restrictions are lifted.

Despite the restrictions, executives technically own restricted stock as soon as it’s granted to them – even before they are vested. As such, they can vote like other shareholders even though they’re under certain other restrictions.

What is a Restricted Stock Unit?

RSUs or Restricted Stock Units work a little differently than traditional restricted stock. Restricted stock is technically a gift of stock given to a company executive while an RSU is a promise of future stock.

Like restricted stock recipients, those who are granted RSU stock must meet certain requirements. This may involve meeting personal or company performance goals, but typically the only requirement for receiving RSU stock is to stay with the company until reaching the specified vesting date. 

In a restricted stock unit arrangement, the employee is not actually granted the stock until he meets the vesting schedule or other requirements. As such, holders of these stock units do not have voting rights or other rights granted to shareholders until the stock itself is officially given to them at a later date. These rights are not granted during the vesting period.

How are RSUs Taxed?

Technically, restricted stock units are a promise of future stock. This means you own nothing, and the IRS won’t tax you until you do. On the day your vesting period ends, your stock units go from promise to reality. This is the day that your stock officially becomes yours. This is known as your vesting date, and from this point forward you own your stock restriction free. 

The bad news is that your new stocks are part of your compensation from your employer and so are taxed as ordinary income. The IRS will tax you on the value of your shares upon your vesting.

If you sell your shares as soon as you own them, you and the IRS need not discuss the matter further. If you choose to keep your shares, however, you may have to pay more tax later. Any stocks you keep are now like any other stocks you own. If and when you sell them, you’ll have to pay capital gains tax (or claim a loss). You’ll be taxed at the short-term capital gains tax rate if you keep your shares for less than a year. If you keep them for more than a year, you’ll be subject to the more favorable long term capital gains tax rate.

For tax planning purposes, some restricted stock unit plans allow you to choose your grant date. This is the date you actually receive your stocks, and it may be different from your vesting date. Choosing the date you take possession of your stock can help you know when you’ll have to pay tax on the stock issuance, but few plans offer this perk. Make sure you understand your company’s rules so you don’t get hit with an unexpected tax bill.

How RSUs Work: An Example

Let’s look at an example for further clarification. Let’s say Bob’s company introduces a new stock plan that offers RSUs. If Bob stays at the company for the next five years, he will be fully vested in the plan and receive 5,000 shares of the company’s stock. For the next 5 years, Bob’s taxes aren’t impacted by this arrangement in any way.

When the 5 years are up, the company gives Bob his 5,000 shares of stock as promised. On that day, the shares Bob receives are worth $1 each. As a result, Bob must report $5,000 of taxable income when he files his tax return at the end of the year. Bob wants to use his $5,000 windfall to buy a used fishing boat, so he sells his shares the same day he gets them. Bob is good to go.

Bob’s coworker Sue takes a different approach. Like Bob, she receives 5,000 shares of stock worth $1 each. Also like Bob, she dutifully reports her $5,000 worth of taxable income to the IRS. But Sue decides to keep her shares. Two years later, their value triples and she decides to sell. 

Sue’s cost basis in her shares is the $5,000 they were worth when she got them. She sold them for $3 a share, or $15,000 total. She now has a long-term capital gain of $10,000 ($15,000 income less the $5,000 cost basis) that she must report to the IRS.

Section 83(b) Election

The Section 83(b) election can save those with restricted stock quite a bit of money if they play their cards right, but it can also be a bit of a gamble. First, it’s important to understand that the 83(b) election is open only to those who have restricted stock. It isn’t an option if you have a restricted stock unit.

You’ll remember that earlier we discussed how executives who receive restricted stock own the stock the day they receive it, even though they may not yet be fully vested in it. In this case, the grant date (the day the stock is received) isn’t the same as the vesting day (the day the stock’s restrictions are lifted).

Ordinarily, owners of restricted stock aren’t taxed on the receipt of their shares until their vesting day. If desired, however, those with restricted stock may elect to use Section 83(b), which allows them to pay tax on the fair market value of their shares on their grant date rather than when they become vested.

If the value of the stock increases between when it is granted and when you become vested, using Section 83(b) can save you massive amounts of tax money. This strategy can backfire though if the value of the stock decreases between granting and vesting, so plan carefully. Typically, the longer the time between receiving the stock and becoming fully vested, the more likely the 83(b) election is to pay off. If the vesting period is five years or longer, going the 83(b) route is likely to benefit. There are no guarantees with this strategy though.

FAQs – RSU Taxes

When is RSU income taxed? 

Your RSU income is taxed only when you become fully vested in your shares. Remember that an RSU is technically nothing more than a promise that you will receive stock in the future, and the IRS doesn’t tax promises. You won’t pay tax until you truly own your shares outright.

Will RSU income appear on my W-2?

Yes. Your stock will appear as income on your W-2 the year you become vested in the plan. Your employer will also report any RSU taxes withheld for you on your W-2.

Is my RSU money taxed twice?

It may feel like the income from your RSU plan gets taxed twice, but it truly doesn’t. The stock does get taxed as income when you receive it, just like your paycheck. It’s also true that you will then have to pay capital gains tax later if you sell the stock, but this isn’t taxing the money twice. This arrangement is exactly the same as what would happen if your boss gave you a taxable bonus check and you decided to use it to buy stock. 

What is the tax rate for an RSU?

When you become vested in your stock, its fair market value gets taxed at the same rate as your ordinary income. The exact tax rate will depend on your specific tax bracket as determined by your income. If and when you sell your stock at a later date, you will pay tax at the current short- or long-term capital gains rate, depending on how long you’ve held the asset.

What happens if I leave my company before I’m vested?

If you leave your job before you’re fully vested in your RSU stocks, you generally forfeit them.

My pay stub shows an RSU offset. What is that?

When you receive the stock promised to you by an RSU, you won’t see an increase in your paycheck. This is because the stocks appear in your brokerage account. The RSU offset is a way to denote the value of the stocks you receive without adding cash to the bottom line of your check. This is a common RSU denotation and is not cause for concern.

Is an RSU plan better than stock options?

Stock options are arrangements by which you can choose to buy or sell shares of stock if and when they reach a specified price. Options are good only for a specified time period and are subject to a lot of rules and terms. As such, there’s really no simple answer to this question. If you’re in a position to choose between the two, the best advice is to consult with a CPA or financial adviser who can help you make the best choice for you.

Professional CPAs

Although we hope we’ve done a good job explaining restricted stock and answering any questions you may have, we would like to acknowledge that this is an extremely complicated tax topic. Even if you’re pretty tax-savvy, we generally recommend speaking to a tax professional about restricted stocks and their tax consequences. At Picnic Tax, our professional CPAs stand ready to guide you every step of the way so you can rest assured that you’re dealing with this complicated issue correctly. We help taxpayers navigate complex issues every day, and we’re always here ready to help you if you need us.