Picture this; you just got a promotion or closed a big deal at the office but instead of seeing a big increase in your next check, your boss tells you that you will start receiving company stock as a bonus.  First off, congrats on the big promotion or big win!  Secondly, what does this mean for your income, retirement, and future tax situation?  In this post, we will lay out some of the basic characteristics of restricted stock units (RSUs).

Now that you are on your way up the corporate ladder, what do these new “stock bonuses” entail?  Each company will differ in the specifics as it relates to their plan; however, there are some basic concepts you should be aware of when you are eligible for units of restricted stock.

1. Vesting – when your boss says you will be getting RSUs as part of your compensation, one of the first things you should know is the plan’s vesting schedule. After all, it is the vesting that makes the company stock “restricted” in the first place. It is most often the case that the vesting schedule will be based on the passage of time.  However, some companies do tie the vesting of RSUs to certain performance metrics, such as sales goals.

Vesting schedules associated with time can be “graduated” or “cliff” in nature.  A graduated vesting schedule will make available a certain percentage of shares each year you are with the company.  As an example, let’s assume you receive 10,000 RSU’s on 12/31/2020 with a 4-year graduated vesting schedule.  This means that you will receive 25% of the 10,000 RSUs each year for the next 4 years.  On the other hand, a 4-year cliff vesting schedule would mean that on 12/31/2024 (i.e. four years later) you would receive the full 10,000 RSU’s.

The type of vesting schedule can make a difference in your expected income and tax situation for a given year.  This is a great segue into our next topic.

2. Tax Implications of Vested RSUs – Great news! When you receive your RSUs you do not have any tax implications. The flip side is you technically do not have access to those restricted shares.  This is one of the big reasons why there are no tax consequences when you receive RSUs.

Where taxes come into play is when the shares finally vest.  Let’s say you are granted 10,000 RSUs on 12/31/2020, and the company has a 4-year graduated vesting schedule.  This means that next year, on 12/31/2021, 2,500 RSUs (25% of the grant) will become vested.  At this time, if the fair market value of the stock is $10/share, you will be taxed on $25,000 of added income during 2021.  This $25,000 of extra “income” will show up on your W-2 at the end of the year and is subject to federal and state income tax, as well as payroll taxes.  It is most often the case that your company will withhold “shares” to settle any tax withholding requirements at the time of vesting.

3. Taxation when selling RSUs – Now that your RSUs have vested, and taxes were withheld, is that all? Nope. You can never get away from Uncle Sam.  However, there are some things that you can do to limit your tax liability going forward.  First off, the price at which your RSUs vest will become your cost basis in the stock.  Let’s say your shares vest when the stock is trading at $10/share.  This becomes your cost basis, almost as if you bought the stock yourself.  The tax implications from here depend on what the stock price is when you sell the stock and how long you have held the stock after the date of vesting.  If you hold on to the shares for say, 6-months, and sell the stock at $15/share, then you will owe capital gains taxes on the additional $5/share.  In this example, your gains would be considered short-term and taxed as if they were regular income since you held the shares for less than a year.  If, however, you held the shares for more than 12-months, the additional $5/share would be taxed as a long-term capital gain and thus receive a preferential tax rate.

All this to say, do not let the tax tail wag the dog.  You should understand not only the tax implications of deciding whether to hold or sell the stock but also how the stock fits into your overall financial picture.  Are you getting more RSUs each year?  Are you thinking about leaving your company?  How much of your overall wealth is tied up in these RSUs?  What about your company’s benefits as a whole?  These are all things you should consider when deciding when to liquidate your RSUs.  Stay tuned for our next post where we help answer some of these questions.

Author: Brett Fry

Brett rejoined Forteris Wealth Management in 2020 and is managing our office in Dallas, TX.  While helping clients plan for retirement, education and generational asset transfers, Brett's expertise in portfolio management, managing concentrated stock positions, planning for the sale of a business, and helping young professionals accumulate wealth enables him to guide clients through their continuously changing financial decisions.