Restricted Stock Units are a popular equity compensation for both start-up and public companies. Employers, especially many startups, use a variety of compensation options to attract and keep top-performing employees. Receiving RSUs allows employees to share in the ownership and the profits of the company. Equity compensation takes different forms such as stock options, restricted stock units, and deferred compensation. If you are fortunate to receive RSU from your employer, you should understand the basics of this corporate perk. Here are some essential tips on how to manage them.
What are RSUs?
A restricted stock unit is a type of equity compensation by companies to employees in the form of company stock. Employees receive RSUs through a vesting plan and distribution schedule after achieving required performance milestones or upon remaining with their employer for a particular length of time. RSUs give an employee interest in company stock but they have no tangible value until vesting is complete.
Companies issue restricted stock units according to a vesting schedule.
The vesting schedule outlines the rules by which employees receive full ownership of their company stock. The restricted stock units are assigned a fair market value when they vest. Upon vesting, they are considered income, and often a portion of the shares is withheld to pay income taxes. The employees receive the remaining shares and can sell them at their discretion.
As an employee, you should keep track of these essential dates and figures.
The grant date is the date when the company pledges the shares to you. You will be able to see them in your corporate account.
You only own the shares when the granted RSUs are fully ‘vested’. On the vesting date, your employer will transfer the full ownership of the shares to you. Upon vesting, you will become the owner of the shares.
Fair Market Value
When vesting is complete, the restricted stock units are valued according to the fair market value (FMV) at that time. Your employer will provide you with the FMV based on public price or private assessment.
Selling your RSU
Once the RSUs are converted to company stock, you become a shareholder in your firm. You will be able to sell all or some of these shares subject to companies’ holding period restrictions. Many firms impose trading windows and limits for employees and senior executives.
How are RSUs taxed?
You do not pay taxes on your restricted stock units when you first receive them. Typically you will owe ordinary income tax on the fair market value of your shares as soon as they vest.
The fair market value of your vested RSUs is taxable as personal income in the year of vesting. This is a compensation income and will be subject to federal and local taxes as well as Social Security and Medicare charges.
Typically, companies withhold part of the shares to cover all taxes. They will give employees the remaining shares. At this point, you can decide to keep or sell them at your wish. If your employer doesn’t withhold taxes for your vested shares, you will be responsible for paying these taxes during the tax season.
Double Trigger RSUs
Many private Pre-IPO companies would offer double-trigger RSUs. These types of RSUs become taxable under two conditions:
1. Your RSU are vested
2. You experience a liquidity event such as an IPO, tender offer, or acquisition.
You will not owe taxes on any double-trigger RSUs at your vesting date. However, you will all taxes on ALL your vested shares in the day of your liquidity event.
Capital gain taxes
When you decide to sell your shares, you will pay capital gain taxes on the difference between the current market price and the original purchase price.
You will need to pay short-term capital gain taxes for shares held less than a year from the vesting date. Short-term capital gains are taxable as ordinary income.
You will owe long-term capital gains taxes for shares that you held for longer than one year. Long-term capital gains have a preferential tax treatment with rates between 0%, 15%, and 20% depending on your income.
Investment risk with RSUs
Being a shareholder in your firm could be very exciting. If your company is in great health and growing solidly, this could be an enormous boost to your personal finances.
However, here is the other side of the story. Owning too much of your company stock could impose significant risks to your investment portfolio and retirement goals. You are already earning a salary from your employer. Concentrating your entire wealth and income from the same source could jeopardize your financial health if your employer fails to succeed in its business ventures. Many of you remember the fall of Enron and Lehman Brothers. Many of their employees lost not only their jobs but a significant portion of their retirement savings.
As a fiduciary advisor, I always recommend diversification and caution. Try to limit your exposure to your employer and sell your shares periodically. Sometimes paying taxes is worth the peace of mind and safety.
Receiving RSUs is an excellent way to acquire company stock and become part of your company’s future. While risky owning RSUs often comes with a huge financial upside. Realizing some of these gains could help you build a strong foundation for retirement and financial freedom. When managed properly, they can help you achieve your financial goals, whether they are buying a home, taking your kids to college, or early retirement.