What are Restricted Stock Units and how do they work?
Restricted Stock Units are shares of a company that are awarded to employees for various reasons such as a signing bonus or performance award. They vest over a period of years which can provide an incentive to stay with the employer. The decision to keep or sell restricted stock units once they vest depends upon many factors and differs from person to person depending on their specific financial position and goals.
To determine if you should keep or sell RSUs, you may want to consider:
- long-term growth potential of the company and underlying strength of its stock,
- tax implications,
- diversification and overall portfolio allocation, and
- alignment with long term investment and career objectives.
For example, let’s say a client is working for a large publicly traded company earning $250k. The client does not have any other income and files taxes as a single filer. The company is pleased with her performance and awards 1,200 shares of Restricted Stock Units that will vest equally over the next 4 years, 300 units per year. The company stock is currently trading at $100 per share. A year later the first group of RSUs vests and the stock price is $125 per share. She will realize income of $37,500 from the vested shares of which the tax will be withheld from the amount that is distributed to her. Her cost basis in the shares is now $125 per share, she now has the decision to keep the shares or sell them. If she keeps the shares, they could increase or decline in value depending on the company’s performance and broader economy. She may sell the shares, that will trigger either a capital gain or loss, and take the cash or reinvest into something else.
- Lets say she keeps the shares for another year and the stock price increases to $140 per share then decides to sell. She would realize a long-term capital gain of $15 per share or $4,500 total and pay 15% capital gain tax on that amount – approx. $675 in long term capital gain tax. Realizing a net gain of $3,825.
- Alternatively let’s say she holds it for a year and the stock price declines to $110 per share, a $15 decline per share and then decides to sell. She would then realize a long term capital loss of $4,500. This can be used to offset other long term capital gains taxes or up to $3000 in ordinary income tax (annually).
- If she sold the shares immediately there would be very little tax impact as the stock price most likely wouldn’t have time to fluctuate and create a large gain or loss.
To sum it up,
- RSU’s are awarded and vest on a schedule, 4-year vesting schedule is common.
- Once RSUs vest they are taxed as income and establish a cost basis.
- Vested shares may be held (if you believe the stock price will increase, you are well diversified and have evaluated alternative options that may align with long term goals) or sold (if sold the cash may be reinvested or spent elsewhere).
- The tax implication from vested shares that are sold depend on the holding period after vesting. If she holds the shares for 12 months or longer, they receive long term capital gains tax treatment, if she sells the shares within 12 months of vesting, they receive short term capital gains tax treatment.
All examples are provided for hypothetical purposes only. Actual results will vary. All investing involves risk including the potential loss of principal. Please work with a tax and legal advisor for your specific situation.