Restricted stock units (RSUs) are a form of incentive compensation granted to key employees as part of an overall compensation package. Typically, RSUs are reserved for executives and other high-level employees.
Unlike traditional stock options, RSUs represent a commitment by the employer to grant a designated number of company stock shares to the employee once he or she has completed a certain vesting period. Once the vesting period is complete, the employee receives ownership of the RSUs.
There are several benefits of receiving RSUs as a form of compensation. First, they provide an additional source of compensation without the employee needing to invest his or her own assets. They also provide an opportunity to share in a company’s growth and success. If the company’s stock price increases significantly over time, so does the value of the RSUs, which can result in significant gains.
Finally, RSUs can help employers enhance their executive benefits packages, which in turn allows them to attract and retain top talent.
However, like many alternative forms of compensation, RSUs present several tax challenges, such as:
- Vesting taxation –RSUs are taxed as ordinary income when the shares are vested based on the shares’ market value. This practice can result in significant tax consequences during the year in which vesting occurs. If the value of your shares significantly increases your tax liability for the year, you may be subject to the alternative minimum tax (AMT), which can be higher than your ordinary income tax rate.
- Long-term capital gains –If you choose to hold your vested RSUs for at least one year after they are vested and transferred to you, the sale will be subject to long-term capital gains rates. The cost basis is the shares’ market value as of the vesting date.
- Short-term capital gains –If you choose to sell your RSUs less than a year after they become vested, the sale will be subject to short-term capital gains rates. The cost basis is the shares’ market value as of the vesting date.
Fortunately, there are several tax planning strategies that can help reduce the tax liabilities associated with your RSUs, including:
- Selling to cover – It may make sense to sell a portion of your newly vested shares to cover your tax obligation. You would then take possession of the remaining shares without paying taxes out of pocket. However, this means you own fewer shares, and you could be limiting your future growth potential.
- Managing vesting – If you have the option to defer or space out the vesting of your RSUs, it may be worth doing so. If you anticipate a year of lower-than-normal income, perhaps due to retirement, you may want to consider deferring taxation until this lower-income year to avoid paying taxes at a higher income tax rate. Similarly, if you have more than one set of RSUs with different vesting schedules, you may be able to spread out the timing of each vesting in order to minimize your tax exposure.
- Donating to charity – From a tax perspective, it may make sense to donate a portion of your RSUs to charity and receive a tax deduction to help offset your liabilities. A particularly tax-effective way to do so is with a donor-advised fund (DAF). DAFs allow you to claim a charitable tax deduction during the year in which a contribution is made to the account, then distribute those funds over time to the charities of your choice.
Could you use some help navigating the financial and tax complexities of your RSUs? We would love to have a conversation. To learn more about how United Capital Financial Advisors can help maximize your executive compensation and lower your tax liabilities, please contact us.
