RSUs: Basics and Taxes (test draft)
Of the common kinds of equity compensation technology professionals receive, restricted stock units (RSUs) are one of the least complicated from a tax perspective, and to an extent, from a planning perspective as well. That doesn’t mean you should ignore their tax or financial planning implications and leave everything on “default”. Doing that puts you at risk for unexpected tax bills, unknowingly overextending your risk budget, and lead to suboptimal decision-making.
Here I’ll go over the basics of RSUs, how and when they’re taxed, and some variables that influence decisions to hold or sell.
What is an RSU?
An RSU is a type of equity compensation that awards the grant holder shares of company stock upon meeting certain requirements (known as vesting). Those requirements can be performance-based, time-based, or dependent on your company transitioning from being a private to a public company (often paired with time-based vesting, which is known as double-trigger vesting). When your RSUs vest, the shares will automatically be transferred to you – no purchase necessary (usually).
How big will my grant be?
The size of your grant will depend on a number of factors and will vary wildly between companies. Typically, a company will award a grant based on an expected value of the compensation. Say they want to award you $10,000 per year in RSUs. They might calculate the grant size based on the current market price, a projected future market price, or some other more complicated calculation. For example, if your RSUs vest over four years, your total award would be $40,000; if they vest in one year, your award would be $10,000 (but depending on your company’s calculation method, it may be more or less based on the market price on the grant date).
The easiest way to calculate a grant’s annual value is to take the total number of RSUs multiplied by the current market price, then divide that by the number of years it takes to fully vest. It doesn't take into account expected price appreciation over time, and it doesn't make a perfect comparison between different company's grants, but it does a pretty good job of estimating the value.
What are some common time-based vesting schedules?
Four years is the length I’ve seen most often, followed by five years. A few companies, like Lyft and Stripe, have apparently changed their vesting schedules to one year. Whether your grant is one year or five years, that's the length of time it will take for your entire grant to vest. Whether you have equal vesting periods, are subject to cliff vesting, or have some other unique schedule, your vesting schedule will tell you when and how many RSUs vest.
Within your grant's overall vesting length, monthly or quarterly vesting is most common. In general, an approximately equal number of shares will vest each vesting period.
Your grant might have a cliff of one or two years where nothing vests until that cliff, and a larger portion vests on the first vesting date. A four-year grant with a one-year cliff often has 25% of the grant vest on the cliff date, but it can be more or less. I recently did some planning around a four-year grant with 20% vesting after year one, and a five-year grant with a two-year cliff, with 33% vesting on the cliff date.
How are my RSUs taxed?
RSUs are (generally) taxed at two points in time: when they vest and when they’re sold. The grant date itself is not a taxable event. We’ll continue the assumption that you don’t need to pay anything to acquire the shares, since that’s generally the case.
The full value of the shares received is taxed as W-2 income when they vest. For example, if 10 RSUs vest when the market price is $50, you’ll add $500 to your wage income and will be taxed accordingly. Since it’s taxed as wage income, you may also have to pay FICA taxes (7.65%) or the additional Medicare tax (0.9%) on some or all of the income, in addition to your regular income tax. The cost basis of the shares becomes the market price (in this case, $50 per share) on the vesting date.
When sold, the difference between the cost basis and the sale price is a capital gain or loss. Gains are taxed at preferential long-term capital gains rates if two conditions are met: sold more than two years from the grant date and sold more than one year from the vesting date. Otherwise, they’re taxed at ordinary income rates (your regular tax rate, but without FICA or the additional Medicare tax). Both long and short-term capital gains may be subject to the 3.8% net investment income tax (NIIT).
If you have a newer grant and are trying to get the preferential long-term rates, watch out for the "two-year from grant" requirement, especially if your RSUs immediately start vesting monthly or quarterly.
In the event you have a capital loss, short-term and long-term losses will offset short-term and long-term gains respectively, then any remaining loss will net against any remaining gain, and if a final net loss remains, it will reduce your taxable income by up to $3,000. Any remaining loss will be carried forward to future tax years.
CAPITAL LOSSES AND THE WASH SALE RULE
If you have a capital loss, you need to be aware of the wash sale rule. Repurchasing shares within 30 days of selling at a loss triggers a wash sale: your loss will be disallowed, and you won’t be able to use it to offset capital gains or reduce your taxable income. The “within 30 days” timeframe is tricky because it also applies if you acquire the “replacement” shares before you sell.
Acquiring shares through RSU vesting or exercising options counts as a purchase, and so does an ESPP purchase. If your RSUs vest monthly, it will be difficult, if not impossible, to avoid triggering the wash sale rule. There’s no point in time where you can sell and have no RSUs vest within 30 days before or after the sale. Even if they vest quarterly, you’ll have a pretty small window to sell in between vesting dates. Throw in options exercises or the purchase period of an ESPP, and you’ll have to navigate around even more potential triggers.
A disallowed loss from a wash sale isn’t lost forever. Instead, it’s added to the cost basis of the “replacement” shares and is accounted for when those shares are ultimately sold. However, incorrectly allowing a loss can lead to additional time and money spent if the IRS decides to call you out on a wash sale. You may have to pay additional taxes, file an amended tax return, and recalculate the cost basis on some of your shares.
What influences how many RSUs I should keep and how many I should sell?
A lot of people forget about the taxes owed as RSUs vest, and the default withholding percentage (typically 22%) is often insufficient to cover the total income taxes on vesting RSUs. The result is an unexpectedly large tax due or smaller refund the following April, which can put some strain on finances if not accounted for.
Your options for tax withholding are usually to pay cash for the withholding (keeping all of the vested RSUs) or to sell enough RSUs to cover the withholding requirement (sell-to-cover). You may also be given the option to automatically sell all RSUs as soon as they vest. When deciding which option to choose (and therefore, how many shares to hold), you should consider a number of factors, including your tax rate compared to your withholding rate, risk tolerance, equity holding situation, and overall financial picture.
As your actual tax rate increases (including FICA, state taxes, etc.), it becomes more expensive to vest into RSUs. With an all-in tax rate of 15%, you only need to pay $1.50 for every $10 of RSUs that you vest into. Contrast that with a 45% all-in tax rate, which requires $4.50 to vest into $10 of RSUs. Higher cost increases your risk.
As the size of your RSU grant increases relative to your overall net worth, it becomes a more concentrated piece of your portfolio and costs more to vest into. Higher concentration and cost increases your risk.
Less savings compared to overall income means less cash flow to pay for the tax costs of RSU vesting and a lower ability to take on risk.
STOCK OPTION GRANTS
As the number of unexercised ISOs increase, it generally becomes more advantageous to leverage selling RSUs to exercise a higher number of ISOs to build equity in a tax-advantaged way. Similar considerations apply to NSOs as well, but without the tax advantages of ISOs.
OVERALL RISK TOLERANCE
Lower risk tolerance implies selling more RSUs as they vest and holding onto less.
All of these variables and others unique to your situation will influence which withholding option is right for you and what sale strategy to implement. I usually don’t recommend electing cash withholding, but there certainly are situations where it would make the most sense. The most important thing is to know how your RSUs will affect your tax, risk, and reward landscapes, and to make informed decisions accordingly.
I hope this helps you better understand your equity compensation and allows you to make decisions with more confidence. Remember that this is general informational and educational content only, and not tax or legal advice, or a recommendation to take specific actions.