Restricted Stock Units: What you should know for taxes, vesting period and more

25 Jan, 2023 0 comments
tax on restricted stock unit

Introduction

Restricted Stock Units (RSUs) are a form of equity compensation that companies use to reward their employees.

They are similar to stock options, but there are some key differences that make them unique. Let’s explore what RSUs are, how they differ from stock options, the tax implications of receiving RSUs, the vesting process for RSUs, and how to maximize the value of your RSUs.

A definition of Restricted Stock Units (RSUs)

An RSU is a grant of a specific number of company shares that is given to an employee as a form of compensation.

Unlike stock options, which give the employee the right to purchase shares at a certain price, RSUs are actual shares that are given to the employee.

The catch is that the employee cannot sell or transfer the shares until they vest.

How RSUs Differ from Stock Options

Stock options are a common form of equity compensation, but they differ from RSUs in a few key ways.

With stock options, employees have the right to purchase shares at a certain price, known as the strike price.

With RSUs, employees are given actual shares, but they cannot sell or transfer them until they vest.

Additionally, stock options have expiration dates, on the other hand, Restricted Stock Units don’t have expiration date.

The Tax Implications of RSUs

When an employee receives RSUs, they are taxed as ordinary income at the fair market value of the shares on the vesting date. This means that the employee will have to pay taxes on the value of the shares at the time they vest, even if they do not sell them.

Additionally, if the employee decides to sell the shares after they vest, they will have to pay capital gains tax on any increase in value since the vesting date.

The Vesting Process for RSUs

The vesting process for RSUs is an important aspect to understand. Vesting refers to the process by which an employee becomes entitled to the shares.

Typically, RSUs vest over a period of time, such as four years with a one-year cliff. This might be different according to the company, your shares might get vested each month for example).

This means that the employee will receive a certain percentage of the shares after one year, and the remaining shares will vest over the next three years. The vesting schedule is usually determined by the company and is outlined in the RSU grant agreement.

YearPercentage of RSUs VestingTotal RSUs Vested
125%25
225%50
325%75
425%100
Example of vesting process in 4 years

This table shows an example of a 4-year vesting schedule with a 25% vesting each year. In the first year, the employee would vest 25% of the total RSUs granted. In the second year, an additional 25% would vest, bringing the total number of vested RSUs to 50. By the end of the fourth year, all 100 RSUs would be vested and the employee would be entitled to them.

How to calculate taxes on Restricted Stock Units (RSUs)?

When an employee receives restricted stock units (RSUs) as a form of compensation, the value of the shares on the vesting date is considered as ordinary income and is subject to income tax.

To calculate the tax on Restricted Stock Units, you will need to know the following:

  • The fair market value of the shares on the vesting date
  • The number of shares vested
  • Your marginal tax rate

You can calculate the tax liability on RSUs by multiplying the fair market value of the shares by the number of shares vested, and then multiplying that amount by your marginal tax rate.

Example of tax on Restricted Stock Units:

  • Fair market value of shares on vesting date: $50
  • Number of shares vested: 100
  • Marginal tax rate: 25%

Tax liability on the tax on Restricted Stock Units = $50 x 100 x 25% = $1250

Maximizing the Value of Your RSUs

Once your RSUs have vested, you will have the ability to sell or transfer them. To maximize the value of your RSUs, it is important to have a plan for when and how to sell the shares.

Once you get the shares, you will have to options:

  • First strategy is to hold onto the shares for a period of time to take advantage of long-term capital gains tax rates.
  • Second strategy is to sell the shares immediately to take advantage of the current market conditions.

It might be better to contact a tax specialist to know which option is the best for you according to your needs and local tax regulations. For example, in the United States, you can take advantage of the long-term capital gains tax if you hold the shares for more than a year.

In conclusion, Restricted Stock Units (RSUs) are a form of equity compensation that can be a valuable addition to your overall compensation package. It is important to understand the key differences between RSUs and stock options, the tax implications, the vesting process and how to maximize the value of your RSUs. It’s always good to consult a financial advisor to help you make the best decision regarding your RSUs.

Restricted Stock Unit Q&A: Tax, cost basis, expiry date

Do Restricted Stock Units expire?

No, Restricted Stock Units (RSUs) do not have an expiration date. You just have your shares are vested, you can keep them or sell them.

Do Restricted Stock Units count as income?

Yes, restricted stock units (RSUs) count as income when they vest. The value of the RSUs on the vesting date is considered as ordinary income and is subject to income tax.

Do Restricted Stock Units have a cost basis?

Yes, restricted stock units (RSUs) do have a cost basis.

What is the cost basis of Restricted Stock Units?

The cost basis is the value of the shares on the date they vest. This means that the employee will have to pay taxes on the value of the shares at the time they vest, even if they do not sell them.

Do you need to pay taxes on Restricted Stock Units?

Yes, you need to pay taxes once your Restricted Stock Untied are vested. For more details, refer to the calculation above in the article.

Learn more on why you should start your journey to achieve financial independence by reading this article.

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