Restricted Stock Units (RSUs) are a form of employer stock-based compensation. Often given to executives or high performing individual contributors, these awards grant ownership in an employer based off certain conditions.
Vesting
When you are granted RSUs, there will be a vesting schedule provided by your employer that determine when the shares are officially yours. Commonly, the vesting is broken up over a number of years and is used by your employer as an incentive to keep you from leaving the company as any unvested shares revert back to your employer.
A common scenario is a three year vest with 1/3rd of shares vesting each year. If you were to receive 300 shares under this schedule, 100 shares would vest in one year, an additional 100 shares would vest in the next year, and the final 100 shares would vest the year after that.
Tax Treatment
No taxes are owed when the shares are granted to you. As the shares vest, they are taxable as income and subject to employment taxes (Social Security and Medicare).
Your employer may provide you with an option to have shares withheld upon vesting to cover the income tax burden associated with the vesting. Similar to paycheck withholding, the amount would be sent to the IRS on your behalf and be reflected on your W-2 at the end of the year.
The value on the day of vesting determines your cost basis in the security and begins your holding period. If you hold the security for one year or less from the vesting date, you will owe short term capital gains taxes on any growth. If held for more than a year that growth, then becomes subject to long term capital gains taxes.
Example: Jane works for ABC Company and as a top performer receives 6,000 RSUs with a three year vesting schedule. The following year, the first tranche of her RSUs vests and she receives 2,000 shares of stock. With the company trading at $50 per share, this means her income will increase by $100,000 for the year ($50 x 2,000). This $100,000 becomes her basis in the stock and two years later when she sells the stock for $115,000 she realizes a long-term capital gain of $15,000.
Strategies to Consider
Limit Concentration Risk
The biggest additional risk anyone who owns stock in their employer takes on is concentration risk. When too much of your net worth becomes tied up in the same place that you give your paycheck, you open yourself up to this risk if something bad were to happen to the company.
Generally, limiting your concentration in any investment to less than ten percent of your investment portfolio is a good rule of thumb. This becomes even more important when that holding is your employer.
Upon vesting, your basis becomes established and an immediate sale of the stock is possible with no additional tax impact. This strategy allows you to reduce the concentration risk with no additional tax burden and then diversify the proceeds.
Have a Sell Schedule
If you choose not to sell all of your stock immediately, having a sell schedule allows you to predetermine when shares would be sold according to a formula. This removes emotions from the decision-making process and provides clear instruction as to when shares should be liquidated.
Exchange Fund
Those that accumulate significant holdings in their company stock with long holding periods may find themselves in a position where significant capital gains would be realized if they chose to sell. One potential solution would be to utilize an exchange fund to achieve diversification without having to sell.
An exchange fund allows you to pool your stock with all other participants in the exchange fund and receive a return equivalent to that of the overall portfolio of holdings within the exchange fund. Once the holding period is met, typically seven years, the shares can then be sold.
Disclosure: Any opinions are those of Michael Dunham and not necessarily those of Raymond James. This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Expressions of opinion are as of this date and are subject to change without notice. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. Investments mentioned may not be suitable for all investors. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. You should discuss any tax or legal matters with the appropriate professional. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation.
