Employee compensation packages can vary greatly between large corporations and start-ups. Some companies have more disposable income to pay out benefits, while others would be better off deferring some aspects of compensation if possible.
Restricted stock units (RSUs) allow companies to promise stock in the future. They reduce a company’s upfront costs, delay stock dilution, and serve as an incentive for employee productivity. When comparing compensation packages, employees need to understand how RSUs are taxed and how they differ from other stock options.
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What are RSUs?
RSUs are a form of equity compensation used by some companies to reward employees for their long-term contributions to the company. They represent a pledge to give an employee a specific number of stock shares, typically after a vesting period. The employee does not own the stock until it is vested. Once vested, the value of RSUs is treated like ordinary income for tax purposes, with the employer normally withholding the applicable taxes by subtracting them from the stock’s value.
What’s the difference between RSUs and stock options?
Stock options give employees the right to purchase shares at a predetermined price after vesting. Employees have the choice of whether to purchase company shares, and they typically make this decision based on the market price. Stock options usually vest over years, which allows for more flexibility in planning the tax implications. Tax treatment depends on whether stock options are incentive stock options or non-qualified stock options.
RSUs represent a promise to give the employee stock after vesting. Employees do not purchase them. Regardless of the current market price, RSUs are converted into shares upon vesting. On the vesting date, RSUs are considered taxable income for the employee. The employer will withhold income and employment taxes based on the value of the RSU.
What’s the difference between RSUs and restricted stock?
Restricted stock is commonly granted to executives in a company. It is non-transferable and can be subject to forfeiture if you leave the company or do not meet benchmarks. The stock is typically transferred to the employee under a graded vesting schedule. Restricted stockholders usually have the same voting rights as other shareholders.
Restricted stock and RSUs are taxed at the end of the vesting schedule. The amount that is declared is determined by subtracting the purchase price (which may be $0) from the fair market price on the date that the stock becomes fully vested.
Restricted stock is eligible for an 83(b) election. Instead of waiting for restricted stock to fully vest and reporting its value as income, another option is to report the fair market value of your restricted stock on the date it is granted. Electing to use the date the restricted stock is granted instead of when it is vested can greatly reduce the taxes you owe because the stock price is typically much lower. If you sell the shares, capital gain and capital loss taxes still apply.
RSUs aren’t eligible for the IRC 83(b) election. This is because the Internal Revenue Service (IRS) does not consider them to be tangible property.
Using the 83(b) election can result in significant tax savings, but it does come with risk. If you leave the company before the stocks become vested, you will lose the value of the stock and the income tax that you have already paid.
What can you do with an RSU?
Once your RSUs vest, you fully own the shares. At this point, you can keep them, transfer the shares, or sell them, depending on your cash flow needs. If your shares increase in value after they are fully vested and you sell them, this would be reported as a capital gain. On the other hand, if your shares lose value, you could end up with shares that are worth less than the income tax you paid on them.
RSUs are favorable to employers because there are no shares to track and record, which reduces administrative costs. Since shares are not transferred to an employee until the vesting period is complete, other costs and share dilution are delayed.
RSUs are favorable for employees because once they are fully vested, they receive the value of the shares plus any capital gains minus income and capital gain taxes. However, RSUs don’t come with voting rights, and they don’t pay dividends before they vest.
There are many different types of restricted stock, each with its own advantages and disadvantages. If your employer offers options in your employee compensation package, talk to your financial advisor to learn how to maximize your retirement income while minimizing your investment taxes.
There is no one-size-fits-all guide to investment. Working with a wealth manager can ensure you make the best financial decisions for yourself and your loved ones.
Gabriel Katzner
In 2002, Gabriel Katzner received his Juris Doctorate with honors from Fordham University School of Law. After spending the first seven years of his legal career practicing at Cahill Gordon & Reindel LLP, an international law firm based in New York, he founded his own firm.
Gabriel identified key limitations in traditional estate planning—particularly the transient nature of client interactions and the suboptimal financial advice clients received elsewhere. Motivated to provide more enduring and comprehensive financial guidance, Gabriel established Frame Wealth Management. His aim was to extend client relationships and enhance their financial strategies, ultimately leading him to become a CERTIFIED FINANCIAL PLANNER™ and a CPWA® professional.
Years of Experience: 17+
