For my clients at public companies, I often frame their RSUs in terms of a cash bonus that's being used to automatically buy their company's stock. If you're scratching your head trying to figure out how that could possibly work out to be the same thing, don't worry. It took a while for it to click in my mind, and that was after I already knew the math behind it. I'll walk through the RSU/cash equivalency and how I use that to reframe the discussion around holding or selling as RSUs vest.
The Tax Equivalency Between RSUs and Cash Bonuses
When RSUs vest, the full value of the shares (number of shares vesting times the share price) is taxed as wage income. This is exactly the same as how an equivalent cash bonus is taxed. For example, 200 RSUs vesting at $50 per share and a cash bonus of $10,000 are both taxed as $10,000 of wage/compensation income. Tax withholding is also identical between the two (it's based on "supplemental income" withholding – generally 22% Federal, plus FICA, plus state income tax withholding as applicable).
This asserts that $10,000 worth of RSUs vesting is, from a tax standpoint, the exact same as receiving a $10,000 cash bonus. One is just paid out directly as company stock (usually net of tax withholding by default), and the other in cash (also net of tax withholding). But this leaves us with stock on one hand and cash on the other. We must now turn that stock into cash and vice versa with no tax impact.
Selling your RSUs immediately after they vest results in no additional tax impact (in theory). This is because your cost basis for capital gains measurement is the price at vesting. Assuming your RSUs vest and are taxed as wages based on a $50/share value and you sell immediately at the same $50/share price, there would be no additional capital gains/losses. Of course, there may be some delay between your RSUs vesting and being sold, even if it’s an automatic election. This may lead to a price increase or decrease between vesting and sale, and therefore a tax impact. However, this impact is generally small in proportion and can generate a gain or a loss, so I’ll ignore it as noise here.
Since the tax impact from vesting into RSUs is the same as a cash bonus of the same size, and immediately selling all RSUs when they vest results in no change in the tax impact, vesting into and immediately selling $10,000 worth of RSUs is equivalent to receiving a $10,000 cash bonus. The reverse is also true since buying stock isn't a taxable event, so vesting into $10,000 of RSUs is equivalent to receiving a $10,000 cash bonus and immediately buying your company's stock.
To further illustrate that whether you start with a cash bonus or RSUs vesting and end up with cash or stock results in the same after-tax outcome, let's add a 30% tax rate into the mix. For simplicity’s sake, we'll assume the 30% tax rate is also the withholding rate, so there’s no need to figure out additional taxes the following April. However, be aware that in practice, the withholding rate may be different than your actual tax rate, so additional taxes may be owed (or you might get a refund).
A Cash Bonus
You get a $10,000 cash bonus, which is taxed 30%, or $3,000. You’re left with $7,000 in your checking account.
A Cash Bonus Used to Buy Stock
You get a $10,000 cash bonus, which is taxed 30%, or $3,000. With the remaining $7,000, you purchase 140 shares of your company’s stock at $50 per share, which is worth $7,000.
RSUs That Remain Stock
You vest into 200 shares of your company’s stock at $50 per share, which has 30% automatically sold to pay for taxes (or 60 shares). You’re left with 140 shares worth $7,000.
RSUs Immediately Sold
You vest into 200 shares of your company’s stock at $50 per share, which has 30% automatically sold to pay for taxes (or 60 shares). You immediately sell the remaining 140 shares at $50 per share. Because the sale price is the same as the price at vesting, there's no additional tax impact, leaving you with $7,000.
How I Think About RSUs and Why
Since you’re ultimately left with $7,000 of cash or stock under any of the above scenarios, the way I suggest my clients at publicly-traded companies frame their RSU decision-making is this:
Ask yourself, "If I were to receive a cash bonus instead of RSUs, would I want to use it to buy my company’s stock at the current stock price?"
If your answer is...
- "No way!" then you may want to strongly consider selling all of your RSUs immediately as they vest.
- "I would take my cash bonus and buy my company’s stock with no hesitation", then sticking with the standard "net-shares" or "sell-to-cover" tax withholding election probably makes sense for you. However, you may still need to sell extra shares to cover a future tax liability if your actual tax rate is higher (e.g. 24% or 32%) than the default withholding rate (e.g. 22%).
- "I’d take my entire cash bonus and even some of my salary to buy my company’s stock", then it could make sense to consider electing "cash withholding" for your RSU tax withholding election (if available). Just be careful of exposing yourself to concentration risk in your company.
Why do I reframe RSU vesting in terms of receiving a cash bonus? Two main reasons. The first is that I’ve found sticking with default options is easy and overcoming the inertia to make changes to the status quo is challenging, even if the default is suboptimal. A non-decision to stick with the status quo is a decision in itself, and reframing the situation can trigger more thoughtful consideration. The second is that equity compensation of any kind can be confusing and even overwhelming, while it’s a lot easier to know what $7,000 in the bank would look and feel like (what’s the tax impact, what does having 140 shares of my company’s stock actually mean for me, do I actually want my company's stock or do I want to do something else with my money, etc). So, reframing in terms of more familiar cash compensation can cut through some of the cognitive burden.
This is just one way you might think about your RSUs. It's not the only way or the "right" way. If you’re getting RSUs at a pre-IPO company or also have other forms of stock compensation, you might want (or even need) to think about your RSUs differently. Regardless, I hope this helps you when deciding what to do as your RSUs vest! If you'd like to discuss your equity strategy in more depth, please feel free to send me an email or schedule a time to talk.