As a key employee of your company, your compensation is often tied directly to the performance of the company. As a part of your compensation you may receive stock options known as restricted stock units (RSU) instead of a cash payment or bonus.
What are Restricted Stock Units?
One of the biggest mistakes young people make after securing their first jobs is getting careless with their spending. While it’s true that you may be making more money now than you have at any other point in your life, this isn’t a free pass to start spending with reckless abandon.
If you don’t already have a budget in place, now is the time to create one using one of the many free apps available. Ideally, you should be allocating at least 10% of your salary to savings. From there, your other essential expenses should total no more than 50% of your income. As you review your budget, take some time to notice where you’re spending more money than you’d like (dining out or entertainment, for example) and cut back.
Are Restricted Stock Units Taxable Income?
Restricted stock units (RSU) are considered to be taxable income. While there is no taxable event at the time the shares are granted, once the shares vest, and you take possession of the shares, this becomes ordinary income to you. The share value will be equal to the fair market value of the shares at the time they vest. The amount of income you receive is included in your W-2 and taxes are withheld based on your withholding elections. This may or may not be enough to cover the entire tax burden for the year. You will want to ensure that you are prepared to pay any additional tax liability that may not be covered by withholding.
For example, based on our example above, let’s say that the 1,000 shares that vest in year one, have a fair market value of $20 per share. The compensation included on your W-2 for the year would include the additional $20,000 in income.
Once you own the shares, the next taxable event will be upon the sale of the shares. If you hold the shares for less than a year, you would be subject to short-term capital gains tax rates equivalent to your ordinary income tax rate.
If you hold the shares for a period greater than one year, you would be subject to long-term capital gains tax rates capped at a maximum of 20%.
As the shares are not considered tangible property to you prior to vesting, they would not qualify for the Internal Revenue Code (IRC) 83(b) election. This election would allow an employee to pay tax on the share prior to vesting. This would be beneficial if the share price at the time of the grant was lower than at the time the shares would vest.
Are Restricted Stock Units the Same as Stock Options?
Stock options are different from restricted stock units in that they typically give the employee the right to receive the shares, even though they would not be required to do so.
Restricted stock units on the other hand, typically provide the employee with a predetermined number of shares over a set number of years that they remain with the company.
Restricted stock units can be a win-win for both the employer and employee of a company. The employer does not have to provide an upfront outlay of cash as compensation to the employee and provides an incentive for the long-term. The employee receives the benefit of the shares which will hopefully increase in value and help tie their compensation to the performance of the firm.
Having a strategy for the vesting of restricted stock units is crucial to avoid any financial pitfalls associated with the potential tax liability when the shares are received and subsequently sold.
If you have any questions regarding this article, or if you need further assistance regarding your unique financial or tax situation, send us an email at info@zagmoutcpas.com, or call us at (312) 239-3716.
To learn more, visit Zagmout & Company CPAs at www.zagmoutcpas.com.
