How are my Restricted Stock Units (RSUs) taxed?
If you receive Restricted Stock Units (RSUs) as part of your compensation, you know that managing their tax implications can often prove tricky. When do you receive them? At one point are they actually yours? When can you sell them? And what are the tax implications if you sell them now versus later?
To make sense of the questions above and, ultimately, to make solid financial decisions with your restricted stock, there are three key dates you must track:
- Grant Date
- Vesting Date
- Sell Date
Grant Date
The grant date is the date your company awards you the Restricted Stock Units. Many companies follow an annual cycle and grant stock compensation awards during the same month each year. Importantly, the grant date has zero tax implications because the shares haven't vested yet. However, you do not have the ability to sell your awarded shares until they vest, which typically occurs over a number of years.
Vesting Date
The vesting date is the most important date to remember. Prior to vesting, you technically do not own the shares. In fact, if you leave the company for whatever reason prior to the vesting date, you will likely part without any of your unvested Restricted Stock Units.
So what happens on the vesting date? This is the date that you officially have “control” and take ownership over your shares. You can sell, hold or gift them as you wish. However, this is also when the taxes start coming due. On the date your shares vest, they are taxable to you at ordinary income rates, which are much higher than capital gains rates.
Can you avoid paying taxes on the vesting date? Nope! This is a common misconception with restricted shares. Contrary to what many believe, there is nothing that you can do to avoid having your shares taxed as ordinary income on their vesting date. You also cannot convert this income to capital gains. (Note: the one exception is if you make a Section 83(b) election, which is more complicated and would certainly require the assistance of a tax professional).
Most employers will help you manage your tax liability by withholding taxes when your restricted shares vest. When this is done, a portion of your shares are withheld for taxes at the IRS' “supplemental rate” of 22% for federal taxes (37% for amounts over $1 million), plus state withholding. If your actual tax rate is higher than this, you will need to make estimated payments or have a balance due when you file your return.
Sale Date
Now that your shares have fully vested, you are free to sell them whenever you would like. Your tax basis for those shares is equal to their value at the time of vesting, which is also equal to the amount of ordinary income that has already been taxed.
The sale date is exactly what you would expect - it is the date on which you sell your shares. On the sale date, you will recognize a capital gain or loss based on the difference in the share price on the sale date and your tax basis (i.e. the value of the shares at vesting). If you sell the shares less than one year after their vesting date, any gains that occurred after the vesting date will be taxed at short-term capital gain rates. If you wait for longer than a year, they will be taxed at long-term capital gain rates.
Since your tax basis is equal to the value of your shares upon vesting, you won't realize any additional gain or loss (or, at least, minimal gain or loss) if you sell the shares immediately upon vesting. For this reason, it is almost always optimal to sell your restricted shares immediately upon vesting.
Case Study
As an example, take the case of Tina, an executive at XYZ company. As part of a promotion in 2020, Tina was granted $100,000 of RSUs that vest over four years with one quarter of the shares vesting on October 1st of each year, respectively.
On October 1st, 2021, Tina's first tranche of shares vest (25% of the initial $100,000 granted). Assuming the stock price hasn't moved for simplicity's sake, Tina will now owe ordinary income tax on $25,000 worth of vested shares. If she sells the shares immediately upon vesting, she will owe no additional taxes. However, Tina decides to hold the shares for 6 months at which time she sells the shares for $27,000, a gain of $2,000.
Next tax season, Tina will have to pay taxes on $2,000 of short-term capital gains ($27,000-$25,000). Because they are short-term capital gains, she will pay taxes at her ordinary income tax rate. If she had held the shares for over 12 months and then sold, her $2,000 gain would have been long-term, and she would have paid taxes at the long-term capital gains rate. Regardless, she will pay tax at her ordinary income rate on $25,000 at vesting.
Conclusion
Restricted Stock Units (RSUs) are a common and often lucrative form of compensation for many executives. However, they can complicate your financial life and arrive with their own unique tax implications. Ultimately, keeping track of the three key dates for RSUs will allow you to more effectively manage your Restricted Stock Units.
Do you have any questions? Please don't hesitate to reach out.
