• RSUs are a valuable form of equity compensation that align employee incentives with company success.
• RSUs vest over time according to a pre-established Vesting Schedule, and employees pay ordinary income taxes on the RSU value upon vesting.
• The value of RSUs depends on the company’s stock price which can fluctuate up or down.

Restricted Stock Units (RSUs) represent a promise to receive shares of company stock in the future once specific (typically time-based) criteria are met. RSUs are the most common form of equity compensation. Some employees receive episodic RSU grants (upon hire, promotion, etc) while others receive consistent RSU grants annually. The value of RSUs is tied directly to the company’s stock price, meaning the value of an RSU award fluctuates with stock market performance. This can be favorable if the underlying company stock appreciates over time but conversely can be unfavorable if the underlying company’s stock contracts over time.

For example, if an employee is granted $100,000 worth of RSUs, the ultimate value of the award will depend on the company’s stock price when the RSUs vest. If the stock price increases from the Grant Date to the Vest Date, the value of your RSUs will rise, and vice versa. This introduces a level of risk, as the final value of the RSUs is not guaranteed (opposed to a cash bonus).

The date on which the RSUs are awarded to the employee. On this date, the employee will receive documentation confirming the award, the number of units, vesting details, and other relevant information for the award.

Vesting is the process by which granted RSUs convert from units to actual shares of stock in the employee’s control. While the “paper value” of RSUs will show up on statements immediately upon Grant Date, it is important to understand that unvested RSUs have no tangible value. Vesting is the key to RSUs having tangible, actionable value.

The time period over which RSUs vest. There are two common types of vesting schedules.

• Cliff Vesting: When the full award vests on one date.  
• Graded Vesting: When a portion of the award vests incrementally over time. For example, 25% of the award vesting per year over 4 years. Or, 33% of the award vesting per year over 3 years.
• Graded Vesting is generally the preferred structure of vesting, due to the employee receiving access to a portion of the award sooner. For example: If an employee receives a 1,200 RSU award on 2/1/2022, but leaves the company on 6/1/2024.
  • Under a 3-Year Cliff Vesting Schedule: The employee would receive 0 of the 1,200 RSUs. This is because all 1,200 RSUs were slated to vest on 2/1/2025.
  • Under a 3-Year Graded Vesting Schedule: The employee would receive 800 of the 1,200 RSUs; 400 vested on 2/1/2023 and 400 vested on 2/1/2024. The employee would forfeit the final 400, which were slated to vest on 2/1/2025.

The date when the employee chooses to sell the vested shares, turning them from company stock into cash. From here, the employee has several options for allocating the sale proceeds (net of any corresponding tax liability). Considerations include retaining in cash savings, paying down debt, earmarking for upcoming expenses, investing for growth, gifting to charity, etc.

RSU taxation can be explained with three concepts: taxation at vesting, mandatory withholding, and taxation after vesting. Understanding these rules can help employees plan for taxes and avoid unexpected liabilities.

Taxation at Vesting:

When RSUs vest, the full value of the vested shares is considered taxable income and subject to ordinary income taxation. This taxation is regardless of whether the employee decides to sell the shares immediately upon vest – OR – hold onto the shares. Said differently, there is no way to avoid the taxation at vest.

Taxable Income at Vest = Number of Shares Vested × Stock Price at Vesting

For example, if 100 RSUs vest and the stock price is $200/share on the Vest Date, the total taxable income would be $20,000 ($200 x 100 shares). This amount would be taxed as ordinary income, subject to federal, state (if applicable), and payroll taxes.

Mandatory Withholding:

A portion of vested RSUs are automatically sold to satisfy the mandatory withholding requirements.  While many employees are shocked, and sometimes upset, to see the “net shares” being substantially lower than the total vested shares, we think the required withholding is helpful to avoid a substantial, surprise tax bill.

It is important to understand the mandatory withholding is NOT always sufficient.

For example, if the mandatory federal tax withholding amount is 22%, but the employee is in the 32% marginal tax bracket, there is a 10 percentage point gap that the employee will owe when filing their return.

Therefore, proactive tax planning is often advised to gain a complete understanding of tax ramifications. Typically this manifests itself through a tax projection, which results in Estimated Tax payment guidance and/or adjusted tax withholding from cash compensation (Salary & Cash bonus). Overall, the mandatory withholding is directionally helpful, but an extra layer of analysis is preferred to avoid tax surprises and potential underpayment penalties.

Taxation After Vesting:

Additional tax liability could be generated if the employee decides to retain RSUs upon vesting. Specifically, any realized gain after the Vest Date is subject to short-term or long-term capital gains taxation. Short-term vs. long-term capital gains treatment is determined by the holding period from the vesting date. If held for longer than a year from vesting, any gain is taxed at long-term capital gains rates. If held for less than a year from vesting, any gains are taxed at short-term capital gains rates. 

If the employee keeps the 100 shares after vesting, their cost basis is $20,000 ($200 per share). After two years, if the stock price rises to $250 per share, the shares are now worth $25,000. If they sell at this price, the $5,000 gain is taxed as long-term capital gains, while the original $20,000 was already taxed as ordinary income at vesting.

As alluded to above, it is important to know RSU awards are conditional on retained employment at the company. Generally speaking, unvested RSUs are forfeited upon separation of service. This can make the prospect of changing jobs or retiring more complicated (and expensive) knowing dollars would be “left on the table”.

• RSU Forfeiture: As alluded to above, it’s important to understand awards are conditional on retained employment at the company. Changing jobs or entering retirement can result in leaving unvested RSUs “on the table”.
• Misunderstanding RSU Taxation: RSUs are taxed the moment they vest, even if you retain the shares. There is no avoiding this. Second, during tax season, it is important to understand the difference between Cost Basis & Adjusted Cost Basis, which can easily be overlooked (resulting in more tax paid).
• Forgetting That Withholding May Be Insufficient: Employers typically withhold at a flat 22% Federal tax rate, but your actual tax rate could be higher. If you’re in the 32%-37% tax bracket, expect to owe extra taxes when filing unless you adjust your withholdings or make estimated tax payments.
• Holding RSUs Without a Diversification Plan: Retaining RSUs after vesting means your wealth is tied to your employer’s stock performance. Consider whether selling and reinvesting in a diversified portfolio makes more sense for your financial goals.