How Do Restricted Stock Units (RSUs) Work?

Tech executives and professionals often receive equity compensation in the form of restricted stock units (RSUs). This article will cover 7 Key Points to Know about RSUs.

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What Are RSUs?

RSUs are grants of company stock that are awarded to employees, and they are subject to a vesting schedule. RSUs have grown in popularity compared to restricted stock (RS) grants, particularly in tech companies, due to their simplicity and full value at vesting. RSUs are more commonly distributed to employees, directors and 1099 contractors.

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What Are the Restrictions?

The most important restriction is that the RSUs need to vest before you take ownership. RSUs are granted to you, but you do not officially take ownership until the shares are delivered to you (usually upon vesting). The vesting schedule will dictate the lapse of the restriction.

You cannot sell or transfer the RSUs until they vest, so they are restricted during the vesting period.

If you leave the company prior to a vesting date, the RSUs are usually forfeited. There are exceptions, such as retirement or disability.

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How Do RSUs Work?

‍Value:

RSUs are tied to the company’s stock price. At the time of vesting, they have full value, unless the stock price goes to zero. Unlike stock options, RSUs do not require a purchase. They have some value upon the vesting date.

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Vesting:

The trigger event is the vesting date. Here is an example of receiving an RSU grant of 2,000 shares that vest 25% over a four year period (500 shares per year).

Let’s say the stock price at each year equals: Year 1 = $75; Year 2 = $60; Year 3 = $85; Year 4 = $110. The total amount vested over the four years will be $165,000.

‍Key Actions:

Keep: Hold the shares and defer selling to a future date.

Sell: Sell the shares immediately..

Gift: In some cases, RSUs can be gifted after vesting.

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Tax Implications

The value of vested RSUs is treated as ordinary compensation income, subject to federal, state, local, Social Security, and Medicare taxes. It is reported on Form W-2. For contractors and consultants, there is no withholding and the income appears on Form 1099-NEC as self employment income.

Companies typically withhold 22% for tax, which is the supplemental wage rate. The withholding rate climbs to 37% for income above $1M in a calendar year. RSU recipients need to be aware that these withholding rates may not be sufficient to cover all tax due on the vested income. So, it may be wise to put extra funds aside or make estimated tax payments to avoid a tax surprise.

There are three common withholding methods. Check with your company to see which methods are available.

‍Share Surrender: Shares are withheld to pay the tax liability.

Sell to Cover: You sell shares to pay the tax.

Cash Pay: You pay the tax directly out of pocket, retaining all the shares

When you sell the shares after vesting, any increase (or decrease) in stock price from the vesting date is subject to capital gains tax treatment (short-term or long-term depending on the holding period). It’s important to report your sale on Form 8949 and Schedule D of Form 1040.

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Voting and Dividend Rights

After grant, but prior to vesting, RSU recipients do not have voting rights or receive dividends. This is because RSUs are not considered to be “property” under IRC Section 83. However, some companies offer dividend equivalents, which can be thought of as a synthetic dividend payment that mirrors the actual stock dividend.

Once the RSU shares vest, you become a shareholder of the stock. You receive full shareholder rights at that time, including voting and dividends.

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Key Decisions To Make

‍Accepting the Grant:

Review the terms of the RSU grant and determine if you need to take action to officially accept/receive the grant.

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Tax Withholding:

Check with your stock plan administrator to understand which withholding methods are available. Determine if you will need to pay additional tax and how you will pay.

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Hold, Sell, or Gift:

‍Decide what you will do when the RSU is vested. How does it fit with your overall financial plan? There are many factors to consider.

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Tax Deferral:

Some Companies offer a provision that allows for the delayed delivery of shares. If available, you generally need to make the election within 30 days of the RSU grant. The ordinary income tax will be deferred until you receive delivery of the shares, but Social Security tax and Medicare tax are still due at vesting. A person would typically elect this tax deferral if they anticipate being in a lower tax bracket in the year of share delivery. An example would be a person retiring or moving to a state with a lower income tax rate.

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Questions to Ask When You Are Granted RSUs

What is the vesting schedule?

Will I forfeit my unvested RSUs if I leave the company?

How do retirement, disability, or changes in employment status affect the vesting of my RSUs?

Will my RSUs be split if I get divorced?

What withholding methods are available?

Can I name a beneficiary designation on my RSUs?

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