Lessons from the Pros


Understanding Restricted Stock Units

What is a ‘Restricted Stock Unit’?

A restricted stock unit (RSU) is compensation offered by an employer to an employee via company stock. The employee does not receive the stock right away. The employee receives it according to a vesting plan and distribution schedule after achieving required performance milestones or upon remaining with the employer for a particular length of time.

The RSUs are assigned a Fair Market Value (FMV) when they vest. Upon vesting, RSUs are considered income, and a portion of the shares are withheld to pay income taxes. Tweet: Upon vesting, RSUs are considered income. https://ctt.ec/nb8B6+ The employee receives the remaining shares and can sell them at any time.

Restricted Stock Units vs. Incentive Stock Options

Incentive Stock options (ISO) Compared to RSUs

With stock options, you can buy company stock on a future date at the price that was current when you received the stock option. For example, if your company gave you a stock option in 2016 when the price was $50 per share, and currently the price is $110 per share, you would pay only $50 per share to purchase the stock and you would gain $60 per stock. The expectation is that the stock price will increase above the strike price so that you can earn the difference between the prices. If the current price of the stock does not go above the strike price then there is no financial gain to the employee.

Typically, the US government taxes vesting securities, such as RSUs, as they vest. This can create problems for employees because they may not have the cash available to pay the taxes.

Options are different. The holder of an option (whether an NSO – non qualified stock option or ISO) does not pay any tax as the option vests, and an optionee that never exercises their options will never pay tax.  NSOs get taxed on the date of exercise. ISOs are even better; with an ISO, there is no tax obligation until the underlying security (stock) is sold.

Although there are no taxes due upon exercise of an ISO for regular tax purposes, the gain upon exercise will be counted towards the Alternative Minimum Tax (AMT) calculation. You should seek the guidance of a qualified tax professional whenever exercising options.

Let’s use an example. Joe received an option grant for 10,000 shares at $1 strike price. To exercise all options Joe will need to pay $10,000. The 10,000 options will turn into 10,000 shares. If the current stock price is $3, Joe will profit $20,000 = (10,000* ($3-$1)).  If Joe holds the stocks for more than 366 days, he will also be eligible for the long term capital gains rate.

Schedule a Free Tax ConsultationThis is a great benefit of ISOs – they can help employees reduce their tax obligation. Most holders of ISOs don’t end up paying taxes at the long-term capital gains rate. Most employees exercise their options right away (a same-day sale). So, in one day, they both exercise their options for shares and sell those shares. This disqualifies them from receiving long-term capital gains tax treatment. They are instead taxed at the short-term capital gains rate, which is equivalent to their ordinary income tax rate.

Unlike ISOs, RSUs do not have a strike price.  This means that they will have some value as long as the common stock has value.  The benefit for employees is that even if a company doesn’t grow its value, the RSUs will remain valuable. An RSU (with equivalent vesting) will be more valuable to employees than an option as you are almost always expected to have some financial gain.

So, the main difference between an RSU and an ISO is that the former may result in a direct cash outlay, whereas, in the latter case you get shares. Of course, if you have an ISO you can choose to turn the stock into cash when you receive the option. If you have an RSU, the company may restrict you to receiving cash only. The choice between receiving money or stocks may belong only to your company. While you may not have to pay out any money for an RSU grant, you’ll need to pay income tax on its fair market value. Since you are restricted from selling the RSU stock for a certain period, you may wish for the stock option which requires no income tax until you sell.

Tax Strategies for RSU

RSU is basically a deferred cash bonus calculated and paid in shares. RSU is taxed to the employee as a cash bonus when they are vested. Any gains after vesting can be taxed as a long-term capital gain if you hold it more than a year. Of course, you can get the same result by simply buying the stock on the open market and holding it for more than a year. Thus, there is no tax advantage of holding RSUs after they vest, since you already paid tax throughout the vesting period.

For more information about stock options, RSUs and other incentive type employer options contact OTA Tax Pros.

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

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