Companies use restricted stock units or RSUs in a similar way to incentive stock options (ISOs) or nonqualified stock options (NSOs). But RSUs are simpler and more straightforward than ISOs or NSOs. This is because RSUs are just shares of your company’s stock while ISOs and NSOs represent the right but not the obligation to purchase company shares at a particular price. Companies use RSUs to save cash (paying you with stock instead of cash), incentivize employees to hang around longer, and to reward employees when the company does well.
RSU Vesting
Just like ISOs and NSOs, RSUs are subject to vesting schedules. Vesting schedules for RSUs can range from several months to several years. When you have met the vesting schedule for RSUs your RSUs will turn into regular shares. The good news is that there is no expiration date for vested RSUs like there is with ISOs and NSOs. The bad news is that upon vesting you will owe income and payroll taxes on your RSUs, regardless of whether you hold or sell the shares.
This means that whenever your RSUs vest, you have 3 basic options: continue to hold the company shares, sell the shares for cash, or diversify all or a portion of your shares. You will owe income and payroll taxes regardless of which route you take.
RSU Taxation
The income and payroll taxes you owe are the market value of the shares on the date they vest. The amount you owe taxes on is the number of shares times the value of the company stock at vesting. The taxes rates are your marginal income rate (your tax bracket) plus Medicare taxes assessed at 1.45% plus Social Security taxes assessed at 6.2%.
There is a way to prepay your income and payroll taxes by making an 83(b) election; but this strategy has many pitfalls and should only be undertaken at the advice of your financial or tax advisor. An 83(b) election allows you to pay taxes on the grant value (i.e. number of shares x price at grant). This is advantageous if you believe the price of the shares will significantly appreciate by the time they vest.
On the other hand, if your shares never vest (e.g. you leave the company) or they drop in value, there is no way to recoup your prepaid taxes. For this reason, 83(b) elections are a risky move unless you have a particular reason for making one.
The safest and easiest thing to do with RSUs when they vest is to either diversify them into other investments or sell the shares for cash. Just because part of your compensation is in company stock, does not mean that you should keep those shares in your company’s stock. Doing so may be more risky than is necessary. Think about it this way; if instead of compensating you with shares, your company just gave you the cash value of the shares, would you turn around and buy your company’s stock with it? If not, then it probably doesn’t make sense to hold on to the shares.
Takeaway
RSUs are pretty straightforward when it comes to equity compensation. You are granted restricted shares in your company. These shares are restricted in the sense that you cannot access them until they vest. When your RSUs vest, they convert to regular shares of company stock in a brokerage account. You will owe income taxes at your marginal income tax rate and Medicare and Social Security taxes (aka payroll taxes) at 1.45% and 6.2% respectively. Diversifying your RSUs after they vest can reduce the risk of holding a significant number of shares in a single company. Diversifying this risk is especially important if the single company you hold shares in also pays your paycheck.