Navigating RSU Taxation

Casey Fenton

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September 2, 2023

When you receive restricted stock units (RSUs) from your employer as stock grants, it's essential to understand the tax implications that come with them such as income tax returns, local taxes, and federal taxes. While RSUs can be a valuable part of your equity compensation package, navigating their taxation can be complex. 

The tax bill on RSUs can be quite a puzzle to figure out due to various factors. First, RSUs are considered income for tax purposes, which means you'll have to deal with income tax implications. 

Additionally, RSUs are often granted through stock grants and can be subject to a graded vesting schedule, which can make things even trickier. 

Depending on your location, local taxes may also come into play, adding another layer of complexity. Keeping track of different vesting schedules of your RSU stock grants, understanding how they impact your tax returns, and managing the intricacies of local taxes can be overwhelming. 

It's crucial to carefully navigate through these complexities to ensure you're accurately reporting and paying taxes on RSU stock grants to avoid any potential issues with the tax authorities. Hence, this article aims to provide you with a comprehensive guide to navigating RSU taxation.

What are RSUs?

Restricted stock units are a form of equity compensation that some companies offer to their employees. They represent a promise from the employer to give the employee a certain number of shares of the company's stock at a future date or when specific conditions are met.

RSUs are different from traditional stock options, which give employees the right to purchase company stock at a predetermined price. Unlike stock options, RSU stock grants are different in that the employer gives the employee the shares outright, without requiring any payment from the employee.

How Restricted Stock Unit is Taxed?

Upon receiving your RSUs as stock grants, you don't pay tax on them immediately. Instead, you pay tax when you sell the shares or when they vest, which means when you become the legal owner of the shares.

When your RSU stock grants vest, which typically occurs over a vesting schedule established by your company, they are considered income and subject to ordinary income tax. This means that the value of the RSUs on the vesting date, based on the stock price at that time, is considered as ordinary income for tax purposes. As a result, you need to be prepared to pay taxes on the value of the RSUs as they vest.

It's important to note that RSU stock grants are taxed differently than stock options. With stock options, you have the option to purchase company stock at a set price, known as the strike price, and the difference between the strike price and the stock price at the time of exercise is considered ordinary income. However, with RSUs, you receive the actual stock or the actual shares when the RSUs vest and the value of the stock on the vesting date is considered ordinary income.

Additionally, when RSUs vest, the company withholds taxes based on the fair market value of the shares at that time. This is known as the "withholding tax." The withholding tax is based on the ordinary income tax rate, plus the Medicare and Social Security taxes.

After the withholding tax is deducted, the RSU stock grant shares are deposited into your brokerage account, and you become the legal owner of the shares. At this point, you have the choice to sell the shares immediately, or you can hold onto them.

If you decide to hold onto the shares, the tax implications depend on how long you hold them. If you sell the shares within a year of vesting, you'll pay short term capital gains tax on the difference between the sale price and the fair market value of the shares on the vesting date. If you hold the shares for more than a year before selling them, you'll pay long term capital gains tax, which is typically lower than short term capital gains tax.

How the Fair Market Value Impacts Taxable RSUs

The fair market value (FMV) of your RSU stock grants at the time of vesting plays a crucial role in RSU taxation. The FMV is typically determined based on the stock price on the vesting date. If the stock price increases between the time the RSUs are granted and the time they vest, the FMV will be higher, resulting in higher ordinary income taxes owed.

It's important to be aware that the FMV of RSUs may fluctuate and can impact the timing and amount of taxes owed. RSU stock grants are subject to income tax based on their FMV at the time of vesting, regardless of whether you sell the shares or hold onto them. This means that even if you do not sell the RSU shares and hold onto them, you will still owe taxes on the FMV of the RSU stock grants at the time of vesting.

Capital Gains Tax on RSUs: What is This?

In addition to ordinary income tax, RSUs can also trigger capital gains tax when the shares are sold. Capital gains tax is the tax on the profit made from selling an investment, such as RSU shares, that has appreciated in value. If you hold onto the RSU stock grants after they vest and the stock price increases further, any gains made when selling the shares will be subject to capital gains tax.

To pay capital gains tax rate depends on how long you hold the RSU stock grants before selling. If the shares are held for more than one year after the vesting date, the gains will be considered long term capital gains and typically subject to lower tax rates, which are typically more favorable compared to the ordinary income tax rate. 

However, if the shares are sold within one year of the vesting date, the gains will be considered short term capital gains and are typically subject to the rates for ordinary income tax.

How to Plan for the Taxation of Your Restricted Stock Units (RSUs)?

RSUs can be a valuable form of employee compensation, but they can also create a tax burden if not managed properly. Here are a few strategies to help you plan for the tax year:

1. Understand the vesting schedules

The vesting schedule of your restricted stock units is the timeline for when you'll become the legal owner of the shares. Knowing the vesting schedule will help you plan for the tax implications of the RSUs and avoid being shocked by your tax bill dues.

2. Plan for the withholding taxes

When the RSU stock grants vest, the company will withhold tax from the shares based on the fair market value at that time. You may need to adjust your budget to account for the reduced income from the withholding tax.

As mentioned earlier, ensure that the company can withhold tax enough RSUs to cover the taxes owed on the vesting date, or pay taxes if necessary. This will help avoid underpayment penalties on your tax return.

By the time your restricted stock units become fully vested stock, the company may automatically withhold at least a portion of the RSUs to cover the taxes owed. This is known as "net withholding," where the company withholds at least a portion of the RSUs to cover the ordinary income taxes owed by the employee. 

It's crucial to understand the process by which they withhold tax and ensure that enough RSUs are withheld to cover the taxes owed to avoid any surprises when it comes time to file your tax return.

3. Consider selling some shares immediately

If you need the cash or don't want to take on too much risk, you may want to consider selling some of the restricted stock units (RSUs) shares immediately after they vest. This will help you avoid short term capital gains tax and reduce your overall tax burden.

4. Diversify your portfolio

Holding too much company stock can be risky, as your investment portfolio will be heavily dependent on the success of one company. Diversifying your portfolio can help reduce risk and ensure that you're not overly exposed to one stock grant.

5. Consult with a tax professional

How restricted stock units RSUs are taxed can be complicated, and it's essential to consult with a tax professional to understand the tax implications of your specific situation fully.

RSU stock grants can be a valuable form of employee compensation, but they can also create complications if not handled properly. Understanding the vesting schedule, planning for the withholding tax, considering selling some shares immediately, diversifying your portfolio, and consulting with a tax professional are all essential strategies for navigating tax consequences on your stock compensation. By taking a proactive approach to managing your RSUs, you can maximize the benefits of this stock compensation while minimizing the tax implications. 

Here are a few additional tips to help you navigate taxation on  your restricted stock units RSUs:

6. Keep track of your cost basis

Your cost basis is the price you paid for the stock grants, and it's used to calculate your capital gains tax when you sell the shares. Keeping track of your cost basis can help you avoid paying more taxes than necessary.

7. Explore Tax Strategies

Work with a tax advisor to explore tax strategies, such as tax-loss harvesting or charitable giving, which may help offset the tax liability associated with RSU income taxed and capital gains tax.

If you're in a higher tax bracket, you may be typically subject to the alternative minimum tax, which is a separate tax calculation designed to ensure that high-income taxpayers pay a minimum amount of tax bill. Understanding how AMT works and how it applies to your RSUs is essential for managing your tax liability.

8. Plan for the timing of the sale

The timing of when you sell your RSU stock grants can have tax consequences. For example, if you sell your shares in a year when your income is low, you may be able to take advantage of a lower tax rate. Conversely, if you sell your shares in a year when your income is high, you may be typically subject to a higher tax rate.

9. Consider charitable giving

If you're looking to reduce your tax liability, consider donating some of your RSU stock grants to charity. By donating the shares, you can avoid paying capital gains tax on the appreciation, and you may be able to take a tax deduction for the value of the shares donate, therefore lowering your tax bill.

10. Evaluate the Holding Period

Consider the holding period for RSU stock grants to determine the potential capital gains tax implications. Holding onto the shares for more than one year after the vesting date may result in lower long term capital gains tax rates, while selling within one year may trigger higher short term capital gains tax rates.

11. Prepare for the Unexpected

Restricted stock taxation can be unpredictable, and it's important to be prepared for the unexpected. For example, if the value of the company stock drops significantly, you may end up owing more in taxes than the shares are worth. Having a plan in place for managing unexpected tax liabilities can help you avoid financial hardship.

12. Pay Estimated Taxes

If the company does not withhold enough RSU stock grants to cover the taxes owed, or if you have other sources of income, such as a cash bonus or other investments, you may need to pay estimated taxes throughout the year to avoid underpayment penalties. It's important to work with a tax professional to determine the appropriate amount of estimated taxes to pay based on your individual tax situation.

13. Consider Tax Benefit

RSUs can also provide a tax benefit. When RSUs are withheld to cover taxes, the employee receives a tax credit for the amount withheld. This can help offset the tax liability associated with RSU income.

14. Section 83(b) Election

Another consideration for RSU taxation is the Section 83 b election. This is an election that allows employees to report income based on the stock price at the time the RSUs are granted, rather than when they vest. If the stock price is lower at the time of the grant, this can result in lower taxes owed. However, the Section 83 b election has strict deadlines and potential risks, so it's important to seek tax advice before making this decision.

15. Be Prepared for a Liquidity Event

RSUs are usually granted by companies that are publicly traded or have plans to go public. If your company has a liquidity event, such as an initial public offering (IPO) or a merger/acquisition, it can impact the taxation of RSUs. Be prepared for potential changes in stock price, FMV, and tax implications as a result of a liquidity event.

Bottom Line

Navigating taxation on restricted stock units RSUs can be complex, but with a little planning and preparation, you can minimize your tax liability and maximize the benefits of this valuable form of employee compensation. By understanding the vesting schedule, planning for the withholding taxes, considering selling some shares immediately, diversifying your portfolio, keeping track of your cost basis, understanding AMT, planning for the timing of the sale, considering charitable giving, and being prepared for the unexpected, you can manage your RSUs effectively and achieve your financial goals on any tax year. 

Taxation for restricted stock units RSUs can be a bit of a maze, and it's no joke when it comes to your finances. So make sure you really understand how are RSUs taxed, plan ahead for the taxation hit, keep an eye on that FMV, and watch out for potential capital gains tax implications. 

It's definitely worth teaming up with a tax advisor and staying in the know about tax laws and regulations on your fully vested restricted stock units. They can help you navigate through it all and keep your tax liability in check. Just remember, for personalized tax advice based on your unique situation, always consult with a qualified tax professional. Better safe than sorry!

Alternatively, we at Upstock can help fill in the gaps with information relevant to RSU taxes, as this type of equity compensation is what we specialize in through the help of our experts and legal team. Hit us up for any questions and breeze your way to the tax filing season.

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ABOUT THE AUTHOR

Casey Fenton

Founder, Upstock & Couchsurfing, AI and Equity Innovator

Casey Fenton, the founder of Upstock & Couchsurfing and an AI and equity innovator, has revolutionized how we perceive and implement equity in the workplace. His foresight in creating platforms that not only connect people but also align their interests towards communal and corporate prosperity has established him as a pivotal figure in technology and community building. Casey speaks worldwide on topics including ownership mindset, worker equity, With Upstock and Couchsurfing, he has demonstrated an unparalleled expertise in harnessing technology for the betterment of community interaction and organizational benefits.

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