Employee compensation is a major expenditure for most corporations.  As such, some firms find it easier to pay, at least a portion of, their employees’ compensation in the form of stock.  This post will discuss the tax implications one should be aware of if they are the recipient of Restricted Stock Units or RSUs.

How do Restricted Stock Unit Plans work?
A RSU represents an unsecured promise by the employer to grant a set number of shares of stock to the employee upon the completion of the vesting schedule.  Once an employee is granted RSUs, the employee must decide whether to accept or decline the grant. If the employee accepts the grant, they may be required to pay the employer a purchase price for the grant.

After accepting a grant and providing payment (if applicable), the employee must wait until the grant vests.  Stock is not issued at the time of the grant.   However, once the recipient of a unit satisfies the vesting requirement, the company distributes shares, or the cash equivalent of the number of shares used to value the unit.

Income Tax Treatment
The following example reflects a salary of $65,000, a grant of 400 shares of hypothetical XYZ Company stock and a sale of said stock one day after vesting.

Step 1: Compensation Income From The Vesting Of The RSU Award
Under normal federal income tax rules, an employee receiving Restricted Stock Units is not taxed at the time of the grant. Instead, the employee is taxed at vesting (when the restrictions lapse) unless the employee chooses to defer receipt of the cash or shares. In these circumstances, the employee will have compensation income or “ordinary income” in tax parlance.  The amount of income subject to tax is the difference between the fair market value of the grant at the time of vesting or distribution, minus the amount paid for the grant (if any).

In our example, the compensation is calculated as 400 shares vesting times the $20 per share fair market price on that date.  The employee now has compensation income of $8,000.  This will also be the stock basis of said shares for use in the next step.  On the employees W2, this $8,000 will be added to the $65,000 in wage compensation and taxed at “ordinary income’ tax rates.

Step 2: Calculating Capital Gains or Losses
For grants that pay in actual shares, the employee’s tax holding period begins at the time of distribution (which may or may not coincide with vesting depending on the plan rules), and the employee’s tax basis is equal to the amount paid for the stock plus the amount included as ordinary compensation income.

In our example, the employee has 400 share of stock with a basis of $8,000.  The very next day they sell all 400 shares when the stock is trading at $22 per share.  The employee has just created a capital gain of $800, which is the difference between their $8,800 sales price and $8,000 basis.  As they held the stock for less than one year between when they obtained it and sold it, the $800 gain will be reported on their tax return as a short term capital gain via Form 8949 or Schedule D (depending on if they had any other adjustments).

Special Consideration – Tax Withholding Choices
Sometimes when one is granted RSUs, they would like the employer to “withhold” some taxes to cover the amount that will be included on their W2 as compensation income.  Generally speaking those options will include:

  • Net Issuance – The employer will deduct a number of shares from your vested shares and give you the rest (broker remits net proceeds to employer, employer remits the value of the deducted shares to Government, money shows up as “withholding” on paycheck).
  • Same Day Sale – If you make this choice, you sell everything on the day of vesting. The employer will then withhold a portion of the proceeds as “withholding” and report them on your W2.
  • Sell To Cover – If you make this choice, or if you don’t have a choice, your employer sells just enough shares to cover the tax withholding. The key difference between Sell to Cover and Net Issuance is that the employer uses a broker in Sell to Cover but doesn’t use a broker in Net Issuance.