Imagine you're a business. You want to compensate your employees but add something more to the mix. What if instead of just offering cash you could incentivize employees to stay with the firm over a long period of time but with ownership of the company? This is where the topic of equity compensation comes into play. If you're an employee for a publicly traded company, then you probably will come across one called a Restricted Stock Unit (also known as RSUs).

Oftentimes, people struggle to understand what they are and how to manage them. Let's break down how this works:

What Are RSUs?

RSUs are a form of equity compensation given to employees as an alternative to cash. Unlike stock options, you don’t need to buy RSUs—they are granted to you, but you don’t own them outright until they vest. The vesting schedule can vary, but typically, once the RSUs vest, they are treated as W2 income, just like your salary. The value of the stock at the time it vests is included in your taxable income for the year.

Example:

Let’s say you have 1,000 RSUs with a $10 fair market value (FMV) when they vest. The value of the RSUs at that time would be $10,000 (1,000 X $10)

This $10,000 is treated as income, and taxes will be withheld accordingly.

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How Are Taxes Withheld on RSUs?

Since RSUs are treated as supplemental income, they are subject to different tax withholding rules than your regular salary. There are two main tiers to consider:

• 22% for income up to $1 million
• 37% for income exceeding $1 million in a calendar year

This flat-rate withholding might seem straightforward, but it can lead to surprises when tax season comes around. Depending on your total income for the year, you might receive a refund or owe additional taxes.

How Employers Withhold Taxes on RSUs

To help manage taxes, employers typically sell a portion of the vested stock to cover the withholding taxes. Here’s an example:

• Suppose 250 RSUs vest at $10 each, totaling $2,500 in value.
• If the 22% withholding rate applies, that’s $550 in taxes.
• To cover this, the employer might sell 55 shares immediately to withhold the taxes.
• This leaves you with 195 shares after the sale.

By doing this, your employer is essentially helping you manage the taxes due on the RSUs, but you still need to be vigilant about the amount being withheld. Employers may not always withhold the correct amount, so it’s important to monitor the vesting process and ensure you’re on track.

Capital Gains Treatment: What Happens After Vesting?

Once your RSUs vest and you take ownership of the shares, the value at the time of vesting becomes your new cost basis (the "purchase price" for tax purposes). This means that the price at which the stock vests is the price you’ll use to calculate any potential capital gains or losses in the future.

Here’s how it works:

• If you sell the stock immediately after it vests and sold at the same price as it did when it vested, you’ll pay taxes on the W2 income portion, and you won’t have any capital gains.
• If you hold onto the stock and sell it later at a higher price, you’ll pay capital gains taxes on the difference between the selling price and the vesting price.

Remember, capital gains rates are typically more favorable than ordinary income tax rates, so holding onto your stock for a longer period can be tax-efficient.

Double Trigger Vesting: What Is It and How Does It Work?

Some RSUs come with double trigger vesting, meaning they won’t vest until two specific events occur:

1. A time-based requirement (e.g., working at the company for a certain period)
2. A liquidity event, such as an IPO, acquisition, or merger

Once both triggers are met, you officially own the stock, and the taxes and vesting process proceed as normal. This type of vesting is more common in startups or private companies that are preparing for a public offering or significant corporate changes.

Whether to Keep or Get Rid Of Them

Now that you have your vested RSUs, the big question is: should you keep or sell the stock? The answer depends on your risk tolerance, your exposure to the company, and your overall financial goals.

Here are some things to consider:

• Concentrated stock risk: If a significant portion of your wealth is tied up in one company’s stock, you may be more exposed to the company’s performance and market fluctuations. Selling some or all of the stock could help diversify your investments.
• Diversification: If you’re already heavily invested in your employer’s stock through RSUs, it could make sense to sell some shares and reinvest the proceeds in a more diversified portfolio.
• Tax implications: Holding onto the stock could lead to favorable capital gains treatment if the stock appreciates. However, selling right away could trigger a tax event based on the stock’s value at the time of vesting.

Ultimately, the decision to keep or sell should align with your overall financial plan and risk management strategy.

Bottom Line: Managing Your RSUs Smartly

RSUs can be a powerful form of compensation, but they come with complexities that require careful planning. Understanding how they are taxed, how withholding works, and the potential tax benefits of holding stock for longer periods can help you manage your RSUs effectively. Own your ownership effectively.

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