Restricted Stock Units (RSUs) are a form of equity compensation that can be provided by an employer. RSUs vest over time and allow an employee to receive shares of the company’s stock or, in some cases, a cash payout. RSUs can be a very beneficial form of compensation, but they require specific and careful tax planning. It is critical to understand the conditions of your RSUs and how they fit into your overall financial plan.
Understanding the Conditions of your RSUs
One important factor to consider when researching the conditions of your RSUs is the vesting schedule. Depending on your specific plan, your RSUs may vest after a specific number of years, or they may follow a graduated schedule allowing them to vest over multiple years. It is crucial to understand the specifics of your vesting schedule because it allows you to be fully prepared for the timing of a potential taxable event.
In certain situations, your RSUs may vest upon a specific performance goal being met. If this is the case, your RSUs may not vest over a specific timeline but rather immediately upon this event or target being hit. Vesting triggers such as performance objectives should be closely monitored to ensure that you are fully prepared for any tax implications.
You should also consider the options your employer provides for deferring your distribution of shares. In some cases, you may be allowed to continue to hold units until a later date, such as retirement. Depending on the specifics of your financial plan and tax situation, deferring the distribution of your shares may be advantageous. By postponing the distribution of your shares, you may be able to coordinate the timing of tax recognition with your overall plan.
Investment Considerations for RSUs
Have you considered what percentage of your overall investment portfolio is made up of your company’s stock? If your company stock makes up more than 10% of your overall investment portfolio you may want to consider additional diversification strategies specifically focused on tax efficiency. Maintaining too high of a concentration in your company’s stock can be particularly risky.
Downside protection is another investment strategy that might make sense while holding your company’s shares. Ensuring that you own investments with a negative correlation to your company’s stock, can offer a safeguard when it comes to the potential drop in value of your company stock.
Ordinary Income Tax Implications for RSUs at Vesting
It is valuable to understand the timing of taxable events when it comes to your RSUs. The receipt of an RSU does not create a taxable event. Income is recognized when the shares of your company stock are delivered, or in other words, when your shares vest. Upon the transfer or vesting of your shares, the fair market value of the shares is considered compensation taxed at your ordinary income tax rate.
Often it is beneficial to consider ways to reduce your income tax liability in the year that your RSUs vest. This can be accomplished by maximizing deductible savings into tax-advantaged accounts such as your 401(k), Traditional IRA or HSA. Careful planning of your deductible expenses can be another option to assist with lowering your tax liability. Finally, the consideration of a donor advised fund for charitable gifts may be another way to reduce your tax burden.
Check with your employer to determine if they offer the IRC §83(i) election. This election could allow you to defer the recognition of your income for up to five years after your RSUs vest.
Capital Gains Tax Considerations at Sale
When it comes time to consider selling your shares acquired through your RSU plan there are a few details to keep in mind. When you sell shares of your stock, you may have capital gains or losses depending on whether the sale price is higher or lower than your cost basis. Your cost basis equals the amount you paid for the stock (if any) plus the amount included as taxable income (see your Form W-2). If you held the shares for longer than one year, your gains or losses will be subject to long-term rates.
There are many issues to bear in mind when it comes to maximizing the benefit of your RSUs. For many investors, RSUs can be used to achieve future financial goals in coordination with income and savings strategies. We recommend using the checklist below to make sure you are fully prepared when it comes to the specifics of your RSUs. If you would like to discuss how your RSUs fit into your overall financial plan, please feel free to schedule a meeting here.
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Melissa Joy, CFP®, CDFA® is President and Wealth Advisor at Pearl Planning. Reach out for a call today at 734.274.6744.