The Basics You Need to Know About Restricted Stock Units (RSUs)
Restricted Stock Units (RSUs) are among the most popular forms of equity compensation today. They’re typically extended to key employees of a company in lieu of cash directly via a bonus, pay raise, or even a portion of salary.
Like all forms of equity, RSUs are an incentive for the employee to have aligned interest in the company’s success. If everyone is contributing towards making the company successful then the expectation is the value of company’s stock would increase and thus increase everyone’s equity holdings, or company stock.
But still, they may seem a little daunting so I wanted to cover some of the basics of RSUs so you can be more informed and confident.
What Are Restricted Stock Units (RSUs)?
Restricted Stock Units (RSUs) are a way for employers to grant shares of their company to key employees.
By receiving an RSU grant, you’ve received a right to your company’s stock, or the cash equivalent for those shares, after you’ve satisfied the specific conditions that your employer has stated in the plan and grant document.
Time vesting is the most common requirement and involves remaining employed with your company for a specific amount of time.
Let’s Talk Value
You may be wondering, “What tangible value do my RSUs have?”
Unlike options, your RSUs will always be worth something. This is unless you leave your company and have unvested options or the company goes bankrupt.
Let me first say, that when you first receive your RSU grant it will likely be expressed in a dollar amount ($75,000). That dollar amount divided by the company share price at grant will tell you how many shares that you’re granted.
Let’s take a look at an example.
Your employer grants you:
$75,000 of RSUs
4-year vesting schedule with a 1 year cliff
In this case, nothing vests during your first year of employment but 25% will vest after 1 year of employment and then the remaining RSUs will vest incrementally over the next 3 years.
The company share price is: $75
Based on this information, the amount of RSUs you’ve been granted is 1,000.
You can also do the math the other way around if you’ve only been given the amount of RSUs you’ve been granted (1,000) and the company’s share price at grant ($75) to get to the same conclusion ($75,000).
(Grant Amount in $) / (Share Price on Grant Date) = # of RSUs Granted
(Share Price on Grant Date) * (# of RSUs Granted) = Grant Amount in $
Again, this grant is simply a promise from your employer until you satisfy the requirements and vest these shares.
However, the price could fluctuate in the time between your receipt of the grant and when the RSUs vest. So just because you have an initial value of $75,000 (in this case) doesn’t mean that’s what you’re RSUs will be worth in the future. And let’s be honest, it won’t have that value because the nature of stock price movements.
Everyone’s happy when the share price goes up but the decline in stock price is one of the risks of receiving equity from your employer as well as working long enough for it to vest.
A Note on Forfeiture
If you leave the company before the units vest then they will be forfeited, you’ll surrender your rights to them. This is referred to as having a substantial risk of forfeiture.
The shares are “restricted” because they are subject to vesting requirements (time or performance). Again, until your RSUs vest they are simply a promise on paper.
What to Know About Your RSUs When They Vest
Once you’ve satisfied the vesting conditions of your employer, your RSUs will officially “vest”.
Once your RSUs vest, two things will need your attention: income taxes and ownership.
How Are They Taxed?
When RSUs vest, the total value is taxed as ordinary income. The taxable income is subject to federal, state, Medicare, and Social Security taxes.
Taxation occurs upon vesting because the risk of substantial forfeiture has lapsed, or in other words you’re taxed because the shares now belong to you. You can’t be taxed on what doesn’t belong to you.
How do we determine the taxable income of the vested RSUs?
# of restricted stock units vesting * Share price at vesting = Taxable income
As you can see, the actual tax liability created will largely depend on the number of shares vesting, the company share price at vesting, and your personal marginal tax bracket (which is determined by your annual taxable income).
Let’s pick back up from our example above and assume the following: you just hit your one-year anniversary and have vested 25% of your RSUs, the share price is now $100, and you’re in the 24% marginal tax bracket.
Step 1: Calculate Taxable Income
Number of RSUs Vesting * Share Price @ Vesting = Taxable Income
250 (RSUs Vesting) * $100 (Share Price @ Vesting) = $25,000 (Taxable Income)
Step 2: Calculate Projected Tax Liability
Federal Tax Owed = Taxable Income * Marginal Tax Rate
$6,000 (Federal Tax Owed) = $25,000 (Taxable Income) * 24% (Marginal Tax Rate)
In this example, your federal tax due would be approximately $6,000.
Do note that you’ll also owe state, Medicare, and Social Security taxes on the taxable income resulting from your RSUs vesting.
State taxes = $25,000 (Taxable Income) * (your state’s tax rate for you)
Medicare = $25,000 (Taxable Income) * 1.45%¹
Social Security = $25,000 * 6.20%²
As you can see, you’ll likely owe more tax than you think when you factor in federal, state, Medicare, and Social Security.
¹ An additional Medicare tax of 0.90% is applied to income over $200,000 for single filers and $250,000 for married filing jointly 2023.
² Social Security tax is only paid on income up to $160,200 for 2023.
Tax Withholding and Payment of Taxes
What’s nice is that most companies withhold the appropriate income taxes and payroll taxes for you when your RSUs vest. They do this by withholding and selling some of your RSUs.
However, the amount withheld may not be enough to cover your full tax liability (mainly federal).
This is because the statutory withholding rate for supplemental income under $1 million is 22%. Once supplemental income exceeds $1 million the statutory rate climbs to 37% where the excess supplemental income above $1 million is taxed at.
So the big risk is under-withholding for those earning less than $1 million in supplemental income but are in the 24% marginal tax bracket or higher. This could result in a surprising tax bill come tax filing season.
So if you anticipate owing more taxes you can:
Check with your employer to see if you can increase the withholding rate on your supplemental income (more and more companies are accommodating for this)
Increase your regular withholdings to withhold more in tax throughout the year
Make quarterly estimated tax payments to cover the remaining tax owed
You’ll also want to consult with your tax professional.
If you’re looking to make quarterly estimated tax payments to cover the difference then you’ll need to set back enough cash each quarter before the due date to make these payments or sell additional RSUs to generate the cash needed.
Finally, it’s worth noting that taxable income resulting from vested RSUs AND tax withheld will show up on your annual W-2.
Hold or Sell?
Upon vesting, the RSUs are yours outright and you now can exercise your right to do with them as you please. You can hold them, and in some cases receive dividend equivalents, or sell them for cash.
The million dollar question is: hold or sell? It also happens to be a very personal one as well.
This decision largely depends on your financial plan and how your company stock fits into that plan.
I know, not the answer you wanted to hear. But I don’t know you or your situation.
Regardless, I do want to say that you want to be very careful of concentration risk from owning too much of your company’s stock, or any one company for that matter.
The Question to Ask Yourself Instead
I may not have given you a great answer but I’ll leave you with a better question to ask yourself.
Ask yourself, “What would you do if your employer paid you a cash bonus instead? Would you use it to buy your company’s stock or do something else with it?”
Most would not buy company stock but instead “do something else” such as fund goals or reinvest elsewhere.
These questions offer great insight by providing a new perspective.
Just because you were paid in stock doesn’t mean it has to stay in stock.
Again, this is a deeply personal question that “depends” on your situation and your goals.
I hope this article has give you a basic understanding of how restricted stock units (RSUs) work. Again, your situation and RSUs are likely unique so please evaluate your plan rules via your company’s plan document and your specific grant document. The best thing to do with your RSUs is HAVE A PLAN!
