Maximize Restricted Stock Units (RSUs)

The 3 Restricted Stock Tax Traps and Options to Save on Taxes Today:

As part of a company’s compensation philosophy, they may want you to be invested in the value that you are helping to create. Therefore, they may award you with an equity grant of restricted stock units (RSUs) as part of your overall compensation.

The purpose of RSUs are to provide incentives to attract, retain and motivate people whose present and potential contributions are important to the success of the company by offering them an opportunity to participate in the company’s future performance through the grant of awards. Traditionally, stock options (if you have incentive stock options, check out our blog on 3 keys to optimizing your ISOs) were an effective compensation component to attract and incentivize high performers, but in the emergence of “unicorn” companies that want to focus on growing/building vs monetization, stock options became less effective and riskier because the employees’ only financial gain would come if the stock price appreciated, which often didn’t happen with growth companies focused on building vs monetizing for quite a long time. The emergence of Restricted Stock Units began at tech companies such as Microsoft, who wanted to reduce the risk of an option expiring worthless for their employee and has now spread through Silicon Valley’s biggest corporations, such as Facebook, Twitter, Yelp and many more.

The following guide will take 5 complexities of RSUs and help to simplify them.

#1: How do Restricted Stock Units work?

Each Restricted Stock Unit is the right to receive one share of common stock upon settlement of your RSUs, following satisfaction of the applicable vesting requirements. Your RSU will vest as set forth in your written Restricted Stock Unit agreement. Generally, within thirty (30) days following the date on which your RSUs vest, shares will be issued to you (such issuance is referred to as “settlement”). Once any shares have been issued to you in settlement of your RSUs, you then own them outright and, subject to the company’s insider trading policy, you may hold, sell or otherwise dispose of them. Unless otherwise specifically set forth in the Restricted Stock Unit Agreement, if you do not satisfy the vesting requirements applicable to your RSUs, the RSUs and any shares issuable upon settlement thereof, will be forfeited.

Many people get RSUs confused with traditional stock options, but an award of restricted stock units differs greatly from a grant of options. Both types are typically subject to vesting requirements, however, unlike an option , RSUs are awarded without an exercise price and, following satisfaction of the applicable vesting requirements, are settled in shares of common stock based on the value of common stock on the date of vesting, without any additional required action by you. RSU Awards typically cover fewer shares than option grants because RSUs retain value, regardless of the performance of the company’s stock price (unless it goes to zero), therefore they are considered more valuable and less risky than options. The value of an option is dependent upon the company’s stock price exceeding the option’s exercise price. If the company’s stock price doesn’t exceed the option’s exercise price, then it expires worthless, and you earn nothing. With an RSU, if the company’s stock price is lower today than it was at the time the lot was awarded to you, then you still have the ability to settle the award into actual stock with a value.

As you can see in the above example, you were granted less RSUs than options, but your risk of earning $0 is significantly reduced.

#2: How will my Restricted Stock Units be taxed?

RSUs have the potential for three tax events you need to be aware of:

• Withholding at vesting
• Vested RSU pushing you into a higher overall tax bracket (could cause additional tax on other sources of income)
• Short-term or long-term capital gains at time of sales (if not sold immediately upon vesting)

At the time you are granted RSUs, you have no tax liability on any RSUs that are subject to a vesting period. At the time the RSU vests, the vested RSU will settle into actual shares and be taxed to you as ordinary income. For example, if you are awarded 10,000 shares of stock that vests quarterly for 4 years, then you will have 625 RSUs settle in each quarter. If the value of your stock is $175 for the first vested quarter, you will report an ordinary income of $109,375 (625 shares x $175/share = $109,375). Your employer may allow you to withhold taxes via a surrender of shares, instead of having to deduct from your salary or write a check to the IRS. Generally, 22% is withheld for federal taxes and 37% for total yearly amounts over $1 million. If you fall between those two brackets, you may need to pay more and should have a tax strategy in place to ensure estimate payments are met.

Sometimes employees compensated via RSUs don’t anticipate the increased tax bracket they get bumped into because of the value of their RSU. For example, if you earn a $225,000 salary then you will fall into a 24% tax bracket (MFJ), but if you have RSUs that vest for another $250,000 you now jump into the 35% bracket and you need a plan for that.

Lastly, if your RSUs vest and you are issued shares, then you are taxed as ordinary income on those shares at vesting. That establishes a new cost basis in your stock position. If within 1 year you decided to sell, and the stock appreciated further, then you will be hit with a short-term capital gain, which is taxed as ordinary income. If you have the ability to delay selling and hold on to the stock for longer than 1 year, that gain would be taxed at much more favorable long-term capital gains rates. It could mean the difference of paying capital gains tax of up to 20% vs ordinary income tax of up to 37% tax.

#3: What restrictions will I have in selling my stock?

The federal securities laws prohibit the taking of short-swing profits by designated insiders. Specifically, Section 16(b) of the Securities Exchange Act of 1934 requires the company to recover any profit realized by a Section 16 insider from any purchase and sale, or sale and purchase, of shares of the company’s common stock made within a period of less than six months. A “Section 16 insider” is an executive officer or director of the company, or a stockholder who beneficially owns more than 10% of the company’s outstanding securities. If you are a Section 16 insider, the company will let you know and you should consult with counsel before offering for sale any shares of common stock acquired under the plan to ensure your compliance. In addition, you may be subject to a 10b5-1 trading plan, creating further restrictions around when you can buy and sell your stock, in addition to other restrictions. For example, you may only be able to buy and sell shares during a 30-day window after company earnings are announced. In addition, you may be prohibited from hedging your positions by purchasing options or derivatives such as call and put options.

#5: How do my RSUs fit into my financial plan?

There is no one-size-fits-all solution when it comes to navigating RSUs as part of a broader financial plan. At Alison Wealth Management, we see three factors that need to be considered:

The first question to ask is: what is the purpose of the money? Many employees need to rely on their RSUs to provide supplemental income beyond their salary. In this case, it is important to ensure that you have a liquidation strategy in order to minimize taxes that could otherwise be avoided.

For employees that don’t need the RSUs for current income, automating a systematic liquidation and investment plan can yield tremendous payoffs in the future. Your starting point is understanding how much of your net worth is concentrated in single company stock and what risks do you and your company face? For most, 100% of their earnings are dependent on the health of the company. If they also have a large concentration of their net worth tied to that same company, they lack diversification and carry excess risk.

The last factor, and one that hopefully your family will never have to address, is what happens if death occurs? With respect to RSUs, there is a chance that your family could forfeit any unvested RSUs at the time of your death. If your family was counting on those RSUs settling into assets to live off of, then you need to ensure you have a strong wealth replacement plan in place if the unexpected occurs.

To learn more about how RSU's fit in your Bucket Plan, schedule a time to meet with one of our advisors.

At Alison Wealth Management, we have years of experience in helping our clients to navigate the challenges and complexities of RSU compensation to ensure they are executed in the most efficient manner, while providing earnings protection to the family of the employee.

To schedule a 20 minute introductory conversation, click here.