Restricted stock units (RSUs) and restricted stock awards (RSAs) are common forms of stock compensation that grant shares of a company’s stock to employees. These awards are subject to certain conditions, typically employment duration or performance metrics, before the employee gains full ownership. This article will define these forms of compensation and provide details to be aware of if you receive them.
How RSUs and RSAs Work
In general, RSUs and RSAs operate similarly but have some slight nuances between the two. A key term is the grant date or the date at which the employer gives you the RSU or RSA stock award.
- RSUs: Represent a promise of company shares to an employee. Upon vesting, the employee receives the shares (or their cash equivalent).
- RSAs: Grant immediate ownership of company shares to an employee, but the shares are restricted until vesting conditions are met.
A key component for both RSUs and RSAs is the vesting requirements. Vesting is the process by which restricted shares become owned by the employee. Vesting often occurs over a set period, such as four years, with a certain percentage of shares vesting each year. Other plans may include a “cliff,” where no shares vest until a specific date, followed by a full vesting of the shares. After your shares become vested, you can determine if you want to sell or keep them.
Tax Implications
Taxes play a significant role in establishing a plan for handling RSUs and RSAs. Below are the key tax aspects of each.
RSUs
- Upon Grant: There are no tax implications when the shares are granted to you.
- Upon Vesting: The fair market value of the shares becomes taxable income.
- Upon Sale: Any increase in the value of the shares after vesting, when sold, is subject to capital gains tax. The capital gains tax rate can be short-term or long-term depending on how long you held the shares.
Example: You receive 200 RSUs that vest over 4 years. At the end of the first year, the company’s stock price is $50, and 50 of your shares vest. The value of your vested RSUs at this time is $2,500. You will owe ordinary income tax on this amount. Often, your employer will withhold the necessary taxes from the shares themselves, reducing the number of shares you receive, but to simplify this example, we will assume you pay taxes out of pocket. When you decide to sell your shares in two years when the share price is at $75, you will owe capital gains taxes on the $1,250 you made.
RSAs
- Upon Grant: Employees have 30 days after the grant date to make an 83(b) election. An 83(b) election allows you to elect to pay income tax on the fair market value of the shares at the time of grant. This can be beneficial if you expect the share price to rise in the future or if you anticipate being in a higher tax bracket in the future.
- Upon Vesting: No additional income tax is due unless the 83(b) election was not made.
- Upon Sale: Capital gains tax applies on any increase above the fair market value that you have yet to pay tax on and is subject to short-term or long-term capital gains rates, similar to RSUs.
Example: You receive 200 RSAs that vest over 4 years. Within 30 days of being granted the shares, you decide to make the 83(b) election when the share price is $30. This means you will owe ordinary income tax on the current value of the shares, which is $6,000. At the end of the first year, the company’s stock price is $50, and 50 of your shares vest. Because you already made the 83(b) election, no additional taxes are owed when the stock vests. If you were to sell the stock at vesting, you would owe capital gains tax on the $1,000 gain ($20 share price increase x 50 shares).
Advantages and Disadvantages
Advantages
- Potential for Significant Returns: If the company’s stock price increases, the value of the RSUs or RSAs can grow substantially.
- Alignment with Company Goals: Can encourage employees to work towards the company’s success.
Disadvantages
- Risk of Loss: If the company’s stock price declines, the value of the RSUs or RSAs decreases. Further, if you make an 83(b) election and choose to pay taxes on your shares before they vest, you have the risk of paying taxes on shares you never receive (if you don’t hit the employment or performance requirements).
- Tax Implications: Understanding the tax consequences is crucial for effective financial planning.
- Lack of Liquidity: Shares may be restricted, limiting the ability to sell.
Summary
RSUs and RSAs can be a key component of individuals’ compensation and overall financial picture which is why it is important to understand them and have a plan to manage them according to your goals. If you have questions regarding RSUs or RSAs you currently receive from your employer, how stock awards may fit into your financial picture, or other financial planning-related items, please contact our team.
