Reaping the RSU Rewards

When looking at employer compensation, especially in the tech industry-heavy Pacific Northwest, restricted stock units (RSUs) are a common method used by companies to incentivize and retain key employees. It is important to understand what RSUs are, their tax implications, and a possible method to minimize taxes.

What are Restricted Stock Units (RSUs)?

RSUs are a promise by the employer to give the employee shares of the company’s stock at a future date – generally upon the achievement of certain conditions, such as employment anniversaries or performance metrics. RSUs are typically granted to employees of many publicly traded companies as part of their compensation package- designed to share equity.

There are myriad timeframes in which granted RSUs can vest, but most typically vesting occurs over a period of time, often 1 to 5 years. Once the RSUs vest, the employee receives the equivalent number of shares of stock. Until that time, the employee does not own the underlying shares and cannot sell or transfer them.

What are the Tax Implications of RSUs?

The tax treatment of RSUs is a very important thing for employees to understand. Generally, RSUs are not taxable when they are granted. Instead, the taxation occurs when the RSUs vest. The employee must recognize income tax equal to the fair market value of the shares they receive on the date of vesting. Because a vested RSU appears as income on your W-2 it is also it subject to Social Security and Medicare taxes.

For example, if an employee is granted 500 RSUs that vest when the stock price is $100 per share, the employee will recognize $50,000 in taxable income. Usually, the employee can make an election with the custodian holding the RSUs to either have no taxes withheld and owe taxes at tax time or have some shares sold at the time of vesting to cover the estimated taxes owed.

If the employee later sells the vested shares, any gain or loss from the sale is subject to capital gains tax. For capital gains tax purposes, the holding period begins on the vesting date, and the tax rate depends on whether the employee holds the shares for more than one year (long-term capital gains) or less than one year (short-term capital gains). As with any tax-related topic, please consult with your CPA to discuss your specific situation.

Tax-Minimization Strategy or Folly? The 83(b) Election

The 83(b) election is a provision of the Internal Revenue Code (IRC) that allows employees to move the taxation of RSU(s) to the date of the grant rather than waiting for the vesting date.

Under the standard rules of the IRC, when RSU(s) are granted to an employee, the employee does not owe taxes until the conditions of employment are met and the restrictions on the stock are lifted, thereby vesting the stock. However, with the 83(b) election, the employee can choose to recognize the income from the RSU(s) at the time of grant, when the stock is still subject to restrictions. This means that the employee would pay taxes on the value of the stock at the time the RSU is granted, even though they are not able to sell or transfer the stock until it vests.

The 83(b) election must be filed with the IRS within 30 days of the grant date and cannot be undone. The key benefit of making the 83(b) election is that any future appreciation of the stock will be treated as capital gains rather than ordinary income. This usually will result in a lower overall tax rate if the stock appreciates.

For example, let’s say the same employee from the above example is granted 500 RSUs with a value of $75 per share at the time of grant. This employee believes that the stock will appreciate significantly and opts to use the 83(b) election. This locks in the tax rate on the $37,500 of income ($75 per share × 500 shares). If the stock price increases to $100 per share when the RSUs vest, the employee will have paid taxes on $75 per share, and the additional $25 per share of appreciation will be taxed at the long-term capital gains rate when the stock is sold.

However, the 83(b) election also has some risks. If the employee elects to recognize income at the time of the grant and the stock value decreases or the employee is laid off and the RSUs do not vest, they will not be able to recover the taxes paid.

CWM can help you navigate your RSUs

Restricted stock units (RSUs) are a valuable and increasingly common form of compensation offered by larger, more established companies. If an RSU is part of your compensation package and you’d like to learn more about how they work and how the team at Comprehensive Wealth Management can help, please Contact Us or call the office at (425) 778-6160 to schedule an appointment with a CWM advisor.

Comprehensive Wealth Management, LLC does not offer tax advice. Please consult your CPA for specific tax questions.