Guest Post: An Introduction to Restricted Stock Units
Updated: Mar 3
Today's post is a guest post from David Lefkowitz, CPA. David is Managing Partner of Lefkowitz & Company LLP, with offices in San Francisco and Miami. David has spent his career advising entrepreneurs, tech executives, and service professionals in matters of tax and business strategy. His business philosophy is built upon the integrity of numbers, of the people behind them, and finding ways to maintain the highest level of both. When not practicing on his ukulele, he and his wife Leslie enjoy travel for great food and opera.
RSUs (Restricted Stock Units) – they really are simple on the surface, but can bring surprise tax costs for the unwary.
The Catch-22 of Restricted Stock Units
Recently a client called me in a panic. The company he works for recently went public, and his unvested RSUs had suddenly became taxable to him. He had just received his pay stub, showing earnings of $720,000 - his regular pay of $15,000 and RSU vesting for $705,000 - but the net pay deposited to his account was only $9,915.40. He had also just discovered that he had to wait 6 months before he could sell his vested shares but that he received taxable income of $705.000, with an accompanying tax bill for $300,000 with no way to liquidate any of his shares to pay for those looming tax liabilities. And because publicly traded shares can change in value daily, he was at the mercy of the market to learn how many shares of his newly received wealth he would need to liquidate to fulfill his tax obligation, never mind add to his investment portfolio.
Taxation of Restricted Stock Units
When RSUs vest, they generate “compensation-type” income to the employee-holder. The employer withholds a portion of the vested value, sells that portion into the market, and remits the net proceeds to IRS and State taxing authorities (the Franchise Tax Board in California). These tax remittance rates are set by statute, a flat rate: 22% to IRS, and 10.23% to Franchise Tax Board. Because the IRS only requires that employers withhold 22%, this often creates a tax liability to RSU holders. Recently, several companies have begun to permit their employees to increase this Federal tax withholding at rates up to 37%, to better match the employee’s transaction cost with their actual tax rate.
Identifying Restricted Stock Units for Sales
Another consideration of RSUs is that IRS considers Restricted Stock as “property” for tax purposes, and when it is sold, taxable gain or loss on the sale is based on the selling price (easy to determine), minus the cost, or tax basis (not always so easy to determine). Basis is “fixed” on the date the RSUs vest, and equal to the market value of the RSUs on that date. Tracking the basis of each RSU award and its vesting schedule is pretty simple math, and many companies offer such a tracking system for their employees. Your tax professional should receive a report of this data for tax planning purposes. The IRS permits taxpayers to “specifically identify” which shares are sold when reporting stock gains & losses on your tax returns. This becomes useful information if you have some shares with a cost of say $32, and other shares with a cost of $72, and you wish to “control the amount of taxable gain on which to pay tax” when the shares are sold.
The vesting date for your shares also starts the “clock” running for long term capital gains treatment, at 20% Federal rates, vs. your “regular” tax Federal tax rate (up to 37%). To qualify for long term gains tax treatment, it requires a one year plus one day holding period, prior to the sale. This is another good reason to track the basis of shares received through RSUs. You can then control both the amount of gain, and the tax rate you will pay on that gain by specifically selecting the shares that you sell.
Holding RSUs vs. Diversifying Your Portfolio
And while tax planning around holding RSUs can add efficiency in their liquidation, many clients prefer to immediately liquidate their vested RSUs, and reallocate those proceeds to their portfolio for diversification purposes. Because the employee has already been “taxed” on the vesting of RSUs as compensation (this amount will appear on your W-2 included in box 1, at the end of the year), you will want to discuss whether holding the vested shares matches your overall investment strategy with your investment advisor.
In summary, RSUs offer many planning opportunities for those who earn them, as well as some potential pitfalls. Your tax advisor and financial advisor can partner with you to minimize the uncertainties of gaining the best outcomes from this equity compensation program.
Contact the Peninsula Wealth Team for a free consultation to begin building a financial and investment plan customized to your goals.