If you are a tech professional for a publicly traded company, you probably receive restricted stock units, or RSUs, as part of your total compensation package.
Restricted stock units can be a great incentive for tech professionals; however, managing them as they accumulate can quickly become complex and overwhelming.
A well-crafted RSU strategy aligned with your long-term financial goals can help give you confidence about your decision-making. After decades of experience working with tech professionals in Silicon Valley, here are answers to some of the top questions asked about restricted stock units.
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Large publicly traded tech companies compete with each other for top talent, and this often leads to unique benefit offerings to incentivize employees. It is important to fully understand what you are being offered, how it will be received, and how you will be taxed. While many public companies offer restricted stock units, their vesting schedules (how you receive them) can differ quite dramatically.
First, restricted stock units or RSUs are not the same thing as stock options. Stock options are typically offered by private companies and should be approached differently than RSUs. If you are currently an employee at a private tech company or may have stock options from a previous employer, check out our resource, “5 Steps to Evaluate Your Employee Stock Options.”
RSUs are typically offered as part of the initial hiring packet. Here are some key terms for us to familiarize ourselves with:
Understanding the time the grant technically starts and how it will vest is a great starting point for decision-making with your RSUs. While employees used to have to wait for a year before a percentage of their RSU offering vested, it is more common now for vesting to start immediately, every month or quarter.
Knowing when and how much of your RSU package will vest allows you to develop an informed tax planning strategy (see below), and it helps you forecast what you might be leaving on the table if you move to a different company.
Let’s look at a sample tech professional employee so we can unpack what exactly is being offered in an RSU compensation benefit package.
The compensation package:
Note: As we noted above, it is common now for vesting to start much earlier. We are using a simple example for demonstration purposes.
What do you actually get from the 100K RSU package? While you get a $ dollar amount at the start of the grant, it may not be exactly what you receive.
The company will take the 100k and divide it by the current share price at the time of grant. If the current share price was $10, you will receive 10,000 shares (100,000 / $10) over the next four years (vesting schedule). Your dollar amount will actually be converted to shares.
Fast forward to one year later, and you receive 25% as part of your original vesting schedule. Instead of 25% of your original $ dollar amount, you will receive 25% of the converted shares.
25% of the 10,000 shares will vest = 2,500 shares
The value of the 2,500 shares will be whatever the stock price is at the time it is vested. This could be higher than the original amount. For instance, instead of $10/share (at the original time of the RSU grant), it could now be $12/share.
An increase in share value can be great for the employee; however, it can also result in unexpected tax liabilities without a plan and strategy. Recognizing the dollar amount to share conversion and how the shares will vest is the first step in thinking through your decision-making.
Next, we explore how the current share price at the time of vesting is converted back into a $ dollar amount and added to your total tax liability for the year.
In our example above, the employee’s original RSU grant was $100,000. At the time of hire date, the $10 original share price was converted into 10,000 total shares over a period of 4 years.
At the end of the first year, 25%, or 2,500 shares, vest.
For tax purposes, total RSU compensation is based on the current stock price at the time of vesting. In our example above, the share price had increased to $12. The current share price ($12) multiplied by the number of vested shares (2,500) is $30,000. This new calculated dollar value of $30,000 is what is added to your W2 as part of your total income.
Let’s say the share price was $8 at the time of vesting, instead of $12. The current share price ($8) multiplied by the number of vested (2,500) is $20,000. In this case, the new calculated dollar value of $20,000 would be added to your W2.
Before the vested shares are actually deposited into a broker account for you by your employer, a certain percentage of your RSU compensation will be withheld for tax purposes. Similarly to a cash bonus, typically about 40% will be withheld for federal, state, local, social security, and medicare taxes.
You will have ~40% of your 2,500 shares sold on your behalf (1,000) to pay taxes, and the remaining 60% or 1,500 shares will be deposited.
If you already had 40% of your RSU taxes withheld, you should be good to go at tax time, right?
Not necessarily. It is a common assumption to think the 40% is enough, and this can lead to unexpected tax liabilities for higher earning tech professionals.
Out of that 40%, approximately 25% will typically be held for federal taxes, 10% for state (California), and 5% for odds and ends like social security and medicare. As a higher income earner, you may already be at a federal tax bracket higher than 25%. If they are only withholding the 25%, you’re going to owe the difference or delta of that 25% and whatever your bracket requires.
For couples where both spouses are working in the tech industry and allotted RSUs, this can quickly become complex to keep track of from a tax planning perspective. Each person’s RSUs are vesting on a regular basis. You may have received refresher grants that are operating simultaneously, and you are vesting in multiple places with different timelines. If you are not withholding enough in taxes, you are quickly going to amass a major tax liability for that calendar year.
Adding to the tax planning complexity, we often see tech professionals who are sitting on all the shares. Your total tax liability could continue to rise with each vesting event, but the actual stocks are sitting there without the liquidity to actually pay the taxes.
This brings us to our next step: restricted stock units (RSUs) don’t mean anything for employees until they are sold, but the “how” and the “when” can also have major tax implications without a clear and thoughtful strategy.
In the previous section, we discussed the total RSU compensation calculation when shares vest, and how that impacts your total W2 tax liability.
For this section, we’re looking at what happens when you actually sell the shares that are in your account (after the original vesting taxes are withheld).
While named “restricted” stock units, RSUs are actually super flexible and have no real restrictions once they vest. They can be sold immediately or kept, whichever best aligns with your strategy.
When thinking about selling your RSUs and tax implications, here are a couple things to keep in mind.
At the moment your RSUs vest, you set a foundational “cost basis” for the value of your allotment. In our example above, 25%, or 2,500 shares vested after one year. If each share was $12/share, the total compensation or value would be $30,000.
The cost basis is incredibly important for understanding what taxes you will owe upon selling the RSUs. If you sell immediately upon vesting, you will not pay any additional taxes as there have been no “gains” since the original cost basis.*
Note: Remember from above, you will owe taxes on the total compensation from receiving the vested stocks, and usually 40% is withdrawn for tax purposes. You just won’t need to pay additional taxes on gains at this point.
Held RSU stocks will vary in share price as time progresses. Sometimes the share prices will decrease in value, but many times it will increase. If your stocks increase in share price from the cost basis, you will need to pay additional taxes on their gains.
For instance, using our example above with the $12/share price, you would have 1,500 shares (after 40% or 1,000 shares were withheld for taxes) worth $18,000. The cost basis of this allotment would be $18,000. Imagine the stock has risen to $15/share in 6 months. Now your allotment is worth $22,500. When you go to sell that allotment, you will owe additional taxes on the $4,500 that has been gained since the original cost basis.
|
Vested Shares |
In My Account |
My Tax Liability |
My Cost Basis |
|
2,500 shares vest at $12/share |
1,000 shares withheld for taxes (40%) 1,500 shares deposited in my account |
$30,000 counted as income (2,500 x $12) |
1,500 shares at $12/share = Cost Basis = $18,000 or $12/share |
|
Increase in Share Price |
My Tax Liability |
|
Increase to $15/share 1,500 shares at $15/share = $22,500 |
$22,500 - $18,000 cost basis = $4,500 Additional taxes on the $4,500 that has been gained |
When an allotment of stocks has increased from the cost basis, has not been held for at least one year, it is subject to short-term capital gains tax when sold. This tax is typically higher than long-term capital gains tax, when stocks have been held for at least one year.
Recognizing which stocks will be taxed at short-term vs long-term capital gains rates will help with your tax planning strategy.
Do my vested RSU shares qualify for long-term capital gains when selling?
Yes! If…
- The share price has increased from the cost basis; and,
- The shares have been held for at least one year.
Each time a “lot” or portion of your RSUs vest, it establishes a particular cost-basis and total value. At that time, additional gains are calculated from that point moving forward, and the 1 year criterion for short-term vs long-term capital gains starts at that point.
We’ve been using a simple example, but tech professionals can quickly find themselves with RSU lots that are vesting either quarterly or monthly, at different cost-basis points, with different timelines for each. When thinking about selling, you need to take all of this into account to optimize your tax planning.
Determining your optimal strategy has much to do with your risk tolerance, how you feel about the company, and how much you want to diversify your portfolio of investments.
Your RSU decision-making really comes down to a question of risk tolerance and how much you want to diversify your portfolio of investments.
As you continue to accumulate more and more shares, your investments become more “concentrated.” This is to say that you are building up more and more reliance on that specific company, and as time passes, more and more of your savings are tied up in the stocks.
We ask our clients, “How much of your personal financial well-being should be tied to your employer?” It may be that you like the idea of building up your savings in a particular company.
For those with a positive outlook on their company and a high risk tolerance, this may be the strategy you want to pursue. Keep these two important points in mind:
Many tech professionals prefer a more diversified, less risky approach, but they are not sure exactly how to manage the RSUs they already have sitting in their account or the new RSUs that will vest in the next 1, 3, or 5 years.
How much of the RSU stock should you keep for that company? How much should you sell and when should you sell it to optimize tax planning? Should you reinvest your sold RSU assets? How much diversification is enough?
Every person, family, and situation should be evaluated on a case by case basis, but here are some good starting points and tips based on all of the variables described in the sections above and our experience over the last few decades working with tech professionals.
We ask our clients to look at their RSUs from a different perspective: if you just got a cash bonus for $30,000, would you turn around and buy more company stock with it?
Most say, “No, I already have a lot of company stock.”
This is a common response! We often recommend: find that number of shares that you are comfortable holding, and repurpose the other shares in a new way. Diversify your investments or liquify for cash needs. The higher your concentration becomes in company stock, the riskier your overall investment portfolio will be.
For clients that have already built up a sufficient amount of company stock, it is often in their best interest to sell RSUs immediately upon vesting.
Why? If you sell right away, there is less of a chance that the price has moved from the original basis cost, and you will not need to pay additional taxes. You will only owe the tax (40% withheld) on the original vesting.
If you just go into your account and sell shares without designating a specific lot, the broker will typically default to the “first in, first out” standard method. Don’t do this! These are often the shares that will have the greatest capital gains taxes.
Instead, be diligent in selling off shares that will have the most favorable tax considerations when it comes to your total liability.
Lots of 5 or 10 years ago may have a low basis, and the price has increased dramatically since that time. Selling these shares will mean much more significant tax implications. You might consider leaving these shares as your long-term hold position.
In contrast, more recently vested shares will have a higher likelihood of being closer to the current market price. Less gains will usually mean less in tax liability overall.
Knowing how to handle your RSUs will maximize the benefit. We see so many tech professionals that come to us with a major accumulation of vested RSU stocks, having stayed in a company for 10 or more years and not having acted on their investments.
Not only have they not been able to see meaningful or tangible benefits from these stocks (having not sold any), they now feel completely stuck. Knowing they’re going to have to pay more taxes, they are unsure about what to do.
A well-developed strategy can help you utilize these stocks and better achieve your long-term financial goals. It’s a great benefit! We don’t want to see you miss out on opportunities.
We’ve worked with tech professionals in Silicon Valley for decades and helped them navigate all of the various compensation options for both large public and private startups companies.
It can become burdensome to manage so many variables on your own, particularly when you start receiving RSU grant refreshers. You don’t want to make a decision that puts you at a loss because you don’t have the cash flow to cover tax liabilities, but you also don’t want to miss out on opportunities to achieve your goals.
Whether you are decades into your career or just starting out, we encourage you to reach out to a financial advisor and talk through how they can help you navigate some of these complexities. You can always reach out to us and set up a complimentary consultation. In addition to RSUs, we are well versed in handling other types of stock compensation benefits such as ESPP or stock options.