Ultimate Beginners Guide to RSUs
Welcome to the ultimate guide for your RSUs, where I’ll be walking you through the savviest of strategies and tips to optimize your RSUs and keep your wealth. I’ll also cover beginner mistakes that could cause you to lose it all.
What are RSUs?
RSU is an acronym standing for Restricted Stock Units. It’s a form of equity used to incentivize employees to 1) build the company, and 2) to retain employees.
How are RSUs taxed?
It’s easiest to address the taxation of RSUs if we look at how they work chronologically.
ST / LT: Short-Term / Long-Term
CG / CL: Capital Gain / Capital Loss
The Grant Date
The first important date to know with RSUs is the Grant date. This is when the company gives you RSUs. You have no taxes on the grant date.
The reason you don’t owe any taxes on grant is because you are only granted a unit, not an actual stock. Your company has imposed some conditions that you must meet in order to receive that stock. Hence the name “RESTRICTED STOCK units.” If you don’t meet the conditions, then you don’t get the stock. Because of this, the IRS views you as having what’s called “substantial risk of forfeiture” (meaning there’s a high chance you could lose everything) so they won’t tax you…yet.
The Vesting Date
You’ll incur taxes on the vesting date. First, let’s understand the term vesting. It refers to one or multiple conditions that need to be met in order for you to receive the shares. The most common types of vesting are time-based vesting, event-based vesting, and performance-based vesting. If there’s a single condition to meet—this is called a single trigger vesting schedule (or double trigger vesting in the case of two requirements). A lot of RSUs have double trigger vesting, contingent upon a 4 year graded vesting schedule and a liquidity event…meaning you need to work at the company for 4 years and the company needs to have a liquidity event (like an IPO or acquisition) in order for the stock to become yours. It’s also useful to know that while shares are vesting, you usually don’t enjoy voting rights, nor dividends. Depending on the company, you may receive accrued dividends when your shares vest. As soon as all vesting conditions are met, the company will transfer your units to stock…that’s when taxes come into play.
There’s no longer a risk of forfeiture and now the IRS feels justified in taxing you, and that’s exactly what they’ll do. You will owe ordinary income taxes on the current value of the stock, subject to withholdings: this means federal income tax, state tax, and FICA (Medicare and social security).
“most companies withhold at one of two tax rates—22% or 37%—which [,,,] might be under-withholding and it’ll be up to you to make up the difference.”
Typically, when you earn a salary from your company, your taxes are withheld from your paycheck. In the case of RSUs, your company may also withhold money to cover the taxes you owe. They may withhold money from your paycheck or sell some of your shares to fund the withholdings. Note that most companies withhold at one of two tax rates—22% or 37%—which might not align with your actual tax rate. Therefore, they might be under-withholding and it’ll be up to you to make up the difference. For example, if your tax rate is 35% and your company only withholds 22%, then it’s your responsibility to pay that missing 13% when your taxes are due. This is where you’ll need to pay quarterly estimated taxes.
Taxes due upon vesting aren’t the last tax ramification you have to worry about. Taxes also come into play when you dispose of your stock.
The Date of Disposition
The date of disposition is the day that you sell, gift, or donate your stock—that’s what they mean by “disposition.” And there are tax consequences here, specifically capital gains if the stock value is higher than it was on the vesting date, or capital losses if the stock value is lower. If it’s been at least one year since the vesting date, you’ll have long-term capital gains or losses—otherwise, they’ll be short-term. And depending on your income, you may also become subject to the net investment income tax (known as NIIT). Be aware that if you have access to insider information for your company, you’ll want to create a 10b5-1 trading plan before you dispose of your stock as an affirmative defense to insider trading allegations.
The nice thing about RSUs is that you don’t have to pay the tax bill out of your personal savings. Let’s talk about these benefits before getting to the potential mistakes you could make with your RSUs.
RSU Benefits
Liquidity
When your RSUs vest and you trigger taxes, you can sell the stock to help fund the bill. That’s one reason why most private companies have a liquidity event as one of their RSU vesting conditions. In stark contrast, stock options don’t have that luxury. When ISO or NSO tax bills come due, oftentimes you can’t sell your shares to help fund the tax bill because the company is still private. In other words, one of the great benefits of RSUs is that tax isn’t due until you have liquidity.
No Exercise Cost
Similarly, benefit number 2 is another victory of RSUs over stock options…you don’t have to pay to receive the shares—or, in financial terminology, there is no exercise cost. If you meet the RSU’s vesting requirements, the shares are yours! Simple as that!
Keep the Value
Because stock options have an exercise price, there’s a chance that the price you pay to purchase the stock is more than the current fair market value of the stock. This is called under-water stock options. Good news! In the case of RSUs, you don’t have to worry about them being “under-water” upon vesting. They will always have value upon vesting…as long as the stock is worth more than $0.
Section 83(i) Election
Another potential benefit is related to a new tax law called the Section 83(i) Election. Ask your employer to see if they offer it. This can allow certain, qualified employees the ability to defer taxation for up to 5 years after vesting. While deferring taxes may be a good thing, there are some potential pitfalls.
RSU Mistakes
Not Immediately Selling
The first and most common mistake I see people make is holding onto their stock after it vests. It’s flawed to think that holding your RSU shares for a long time will bring some added tax benefit.
To prove my point, let me show you a graph of tax outcomes if you were to go out and buy any regular stock.
Now, let’s compare this to the tax ramifications of RSUs after they vest.
Do you see a difference after vesting? Neither do I. That’s because, outside of the stock being given to you upon vest, RSUs provide no added benefit over regular-ol stock. In fact, the only thing it brings is added risk, which leads us to the next mistake—over-concentration.
Over Concentration
Being over-concentrated in your company is a HUGE mistake. Think about it, you may be overexposed to your company via your salary, stock options, RSUs, and so on…putting your income and your assets into a single, effective “basket.” If anything terrible were to happen to the company, you could lose your income AND your assets—which could be devastating to your net worth and cash flow. Talk about a double whammy!
This risk is so subtle and sneaky because it happens without you even doing anything. As your RSUs vest, you passively become over-concentrated. If you didn’t have RSUs, would you have gone out and spent large portions of your net worth on your company shares? Probably not! Please don’t forget the importance of diversification. If you're looking for a professional to help you diversify out of your company in a tax-efficient manner, my firm specializes in this and we have some limited room for new clients. More information here.
Not Understanding Taxes
Here’s the catch, oftentimes people try to offset concentration risk by implementing other strategies that end up hurting them in the process. Most of this comes from the next mistake…not fully understanding tax implications.
Hedging Risk
One way people try to offset or hedge this risk is by engaging in complicated financial strategies or products such as writing calls and puts. While often not recommended (nor permitted), just know that if you perfectly offset the risk with calls and puts, the IRS will treat you as if you sold the stock and you’ll have to pay tax on it. This is called constructive receipt—when the IRS taxes you as if you’ve received income, but you haven’t actually had any of those dollars hit your bank account . Can you see all the different things we’re trying to balance here with your RSUs?
Wash Sales
Another tax mistake is triggering wash sales. When you sell stock for a loss, the government is willing to let you write that off to offset other income and gains. But what they don’t want you to do is sell for a loss and then quickly buy back that same stock or one that is substantially identical. If you do this, they will disallow the loss. This is called the wash-sale rule. So if you’re trying to sell some stock for a loss, be aware that RSUs vesting could be interpreted as purchasing stock, disallowing any losses. So you want to ensure that you’re correctly aligning any losses you’re writing off with the important dates of your equity.
Trailing Tax Liability
Yet another tax mistake is when you’re so smart that you scheme to reduce your tax bill by moving to a different state that has little-or-no income tax. The reality is, you might not be able to escape. Some states have a trailing tax liability which means you may still owe them taxes, even if you’ve long-since moved.
We’re covering a lot, so I’ve created a free cheat sheet available for download below.
RSU Guide
83(b) Election
I’m going to let you in on another gotcha. There's something called the 83(b) election which allows you to lock in the tax bill at the grant date and have all subsequent gains taxed as capital gains when they vest. The problem is that it actually doesn’t apply to RSUs. So many people get confused by this. It applies to Restricted stock, but not restricted stock units. I know it’s confusing, but those are two separate things and I thought I’d address it so you know. Restricted stock, restricted stock grants, and RSA’s, all enjoy the 83(b) election…RSUs do not.
While most of the tax mistakes thus far have been caused by people trying to outsmart the system, this last one comes more from ignorance or unawareness.
Under-withholding
Your company may not withholding enough money to cover the tax bill. This extra large tax bill may come as a surprise if one doesn’t know about withholdings. This problem can be compounded by something I’ll address in the tips portion.
Double Taxation
Let’s take a quick look at how your RSUs can get double taxed. When your RSUs vest, they are correctly reported as income on your W2. A problem arises, however, if your broker (such as E*Trade or Fidelity.) reports that same income on Form 1099-B. To avoid this mistake pay attention to your cost basis on your 1099-B. You may have to make an adjustment to avoid double taxation.
Behavioral Bias
Another common mistake I see is a cognitive error that creates mismanaged expectations and can cause financial ruin. This mistake is when you start to calculate how much your RSUs are worth. There’s a few problems with this: First, you haven’t earned them yet. You could still lose them if the full vesting conditions are never met. Second, you're not guaranteed that the shares will be worth as much as you expect when they do vest and third, you probably didn’t account for the taxes that you will have to pay. And your tax could be as high as 50%. I’m going to talk about ways to potentially decrease the amount of tax that you pay on your RSUs when I get to my tips.
Let’s say you are expecting a $200k RSU payout, you will likely start to increase your lifestyle and imagine all of the things you will be able to buy. When in reality, you may only receive $75k after taxes and stock price movements. This could be detrimental to your financial future. That’s why I say, whatever you think they’re worth, just disregard that … because expectations are an appointment for disappointment.
Leaving/Quitting Before Important Vesting Dates
One of the last mistakes I see is when people don’t pay attention to their vesting schedule and leave the company before an important vesting condition is met. While I don’t want you to make any decision solely based on equity alone…It’s worth looking into when your RSUs vest. That way, you’re not jumping ship (or leaving your company) if an important vesting condition is coming soon. If you leave early, you lose all of your unvested RSUs. In this respect, everything can be at stake.
Just know that your company may try to leverage RSUs to get you to stay longer. Here are a few of their strategies:
Get you to take a lower salary for increased equity, making the equity seem more valuable than a salary.
Have a monthly vesting schedule which makes it difficult for you to leave because you start thinking, “If I stay another month, I’ll get those additional RSUs vested!.”
Lastly, they'll never let you fully vest. As soon as you approach being 100% vested, they'll give you another RSU grant to incentivize you to keep working longer.
If you’re finding value in this, please share it with others who have RSUs.
Don’t make decisions based on what the company wants from you. Instead, take a holistic approach to making decisions. Here are some strategies to help:
RSU Strategies
Sell Immediately
The first approach is selling everything immediately upon vest. As I’ve already shown, beyond this point RSUs provide no benefit over any other stock. So selling everything immediately can reduce the concentration risk of your investments. Don’t worry, if you sell immediately on vest, you won’t owe any taxes beyond those due on the date of vest. Depending on your unique circumstances, a well diversified portfolio may be a good place to place for your proceeds unless you need that cash in the next few years. Be aware that this approach does remove you from any future stock appreciation, though.
Even if you’re planning on buying back in, I want you to see the proceeds in cash. This will cause you to reflect and decide if that’s really the best way you want to invest your money.
Selling Over Time
Look, I get it. You’ve worked hard for your company, and you believe in its future. So it may be hard to immediately let go of your company stock. Good news is, you don’t have to do it all at once. Behaviorally, you may be able to stomach selling in increments, for example 20% a year or some other variation. If the stock appreciates, there are tax efficient ways to unwind such positions, such as gifting to a charity to avoid realizing any gains. There are more tax planning strategies that may apply to your unique circumstances.
If you're looking for a professional to help diversify out of a company in a tax-efficient manner, my firm specializes in this and we have some limited room for new clients. More information here.
Hold Indefinitely
A third strategy is to hold the stock indefinitely. I’m going to guess more people do this than they should. Not because they’re making a deliberate choice to invest in their company, but because this is the result of inaction—which is kinda unfortunate.
While it may make sense to do this, you have to be aware of the risks—which I’ve already covered when talking about over-concentration. That being said, if your company stock performs well, then you get to enjoy that appreciation. So it’s a balance of risk and reward.
The more your finances are healthy and in order, the more likely you can afford to take this approach if you so choose. You can tell your finances are healthyFor instance, if you’ve got an emergency fund in place, minimal low-interest debt, a healthy retirement savings, excellent savings rate into a diversified portfolio, you’re maxing out your company’s 401(k) match, you have sufficient income to meet your obligations, and other unique factors to your personal situation.
Even if you choose to hold the stock indefinitely, you should still sell some shares immediately to cover any tax under-withholdings. I’ve worked with people who thought they’d sell later…after the stock went up…but the stock actually went down. So they had to pay BIG tax with SMALL stock proceeds. Don’t try to outsmart the system here.
Speaking of trying to outsmart the system, this leads us to the first of three RSU tips I want to share with you.
RSU Tips
Make a Plan
I want you to be proactive, not reactive. If you don’t have a plan, then you become subject to your emotions and you’ll try to outsmart the system—most of the time to your disadvantage. So you’ll want to have a plan for when you exit. For example, you may choose one of the strategies I just covered as a starting point. You’ll also want a plan for your proceeds—ideally before they even vest. Yes, you shouldn’t be anticipating a certain dollar amount, but do you have a general job for that money to do? A down payment on a home? Funding a child’s education?
When you read the RSU documents given to you, make sure to highlight the important facts. Literally write down the vesting dates—as this can help you avoid wash sales or leaving the company before a big payout. It can also help you optimize tax brackets and decrease tax ramifications through planning with a professional. While not an exhaustive list, here are some tax-efficient options you might consider:
Contributing to a 401(k), HSA, or traditional IRA (depending on your income)
Deduction clustering
Charitable deductions (DAF, CLT, CRTs)
Paying off medical expenses
Paying state and local taxes
If you're looking for professional help, more information here.
Manage Expectations
I think it’s fair to say that your RSUs aren’t going to be worth what you think they're worth—either for better or for worse. If you don’t understand the taxes, you’ll definitely be disappointed in your final proceeds. While there’s no way of knowing exactly what your stock is going to be worth on the day of vesting, you want to ensure that you show up with a plan AND you show up without expectations. I want you to be informed, but I don’t want you to be raising your lifestyle to some lofty expectations. Fair? Cool.
Treat RSUs as Cash
This is a behavioral trick to help you view your RSUs more clearly and help you make better plans. When your RSUs vest, think of them as a cash bonus. How would you spend that cash? When making financial decisions, emotions and cognitive biases can murky the water. We need these removed from the situation, because your finances are on the line. Treating your vested RSUs as cash can help. If you decide to sell your stock immediately, it can quite literally make you think in terms of cash. This approach counters your misconceptions and behaviorally forces you to think hard before you buy back into the stock.
