What are RSUs?
Restricted stock units (RSUs) are a type of stock that companies often grant to employees as an incentive to remain with the company and contribute to its growth. Unlike stock options, which grant the right to purchase stock at a specified price, RSUs do not have to be exercised. Instead, they vest (become full property of the employee) according to the schedule described in the grant agreement.
How do RSUs vest?
The vesting schedule defines the events that trigger transfer of RSUs to employees. Often a single event, time in service, triggers vesting. For example, the grant agreement might stipulate that shares begin vesting after one year in service at a rate of x shares per month over the course of y months. In other cases, a second triggering event—often an IPO or change in company ownership—must occur before shares vest. As a result, employees who receive double-trigger RSUs often see all or a large portion of their shares vest at once.
How are RSUs taxed?
Employees are taxed on the value of RSUs at the ordinary income rate at the time they vest. This includes Social Security and Medicare taxes, and states may also impose their own taxes on RSUs. RSUs are included with wage income, and employers commonly withhold taxes—as cash, a portion of the vesting RSUs, or both—when transferring them to employees. However, wage withholding is often lower than the taxes owed on the transaction. When employees sell their shares, any gains are treated as capital gains.
How does a double trigger affect RSU taxation?
Because double-trigger vesting can cause a large proportion of an RSU grant to vest at once, it can create a steep increase in taxable income in a single tax year. As a result, it is especially important to engage in proactive planning to mitigate the resulting tax liability. You may need to increase your withholding or make estimated tax payments to ensure your tax bill is covered.
While you may be able to sell some shares to meet your tax obligation, you will likely be subject to post-IPO lockup and blackout periods that restrict your right to sell. Also, keep in mind that gains from the sale will incur capital gains tax. If you’ve held shares for less than a year, short-term capital gains rates, which are essentially the same as ordinary income tax rates, will apply.
How can I limit the tax consequences of double-trigger RSUs?
One way to soften the blow of double-trigger RSU taxation is to reduce your overall taxable income for the year. There are a number of ways this can be accomplished.
If your employer offers a nonqualified deferred compensation plan, this can be a simple way to defer a portion of earned income and related taxes until a future year (for example, the year you plan to retire). This can allow you to not only save on taxes in the current year but also establish income for the future, when you may need it more, and potentially be taxed on it at a lower rate. If you have other income that can be deferred, such as collections on invoices for a spouse’s business, this can also help reduce your tax bill in a double-trigger vesting year.
The other way to reduce tax liability is to increase your deductions. Examples of ways to do this include
- Maxing out contributions to a 401(k) or other qualified retirement plan, which defers taxation of your contributions until they’re withdrawn
- Maxing out HSA contributions, which can be tax-free when managed appropriately
- Donating to your favorite charities
Donor-advised funds provide a simple way to donate your appreciated stock rather than cash. Donor-advised funds pool donations from multiple donors, which are then administered by a third party (often a financial institution).
In general, taxpayers who itemize can deduct up to 60% of AGI in charitable contributions. If you’ve held shares of stock for more than a year, you may also be able to donate these as well. Donations of stock can be deducted up to 30% of AGI and carried forward for up to five years. A small percentage of U.S. charities accept direct donations of stock; however, it’s possible to donate to a wider selection of charities via donor-advised funds or charitable trusts.
What else should I consider when planning for RSU vesting?
As with all aspects of financial planning, the foundation for all decision-making should be your individual financial goals. When you have a clear vision of what you want to do with your wealth and when, you’re best positioned to work with your financial advisors to develop a detailed strategy to make that vision a reality. For example, knowing your target retirement date and desired income and anticipating large costs like college tuition or home purchases enables you to develop a plan to meet those specific expenses. Work with a trusted fiduciary advisor to craft a plan that fits your personal vision.
WRP Wealth Management specializes in working with pre-IPO employees. We can help you understand the complexities of the IPO process and create a financial plan using evidence-based strategies to make the most of this once-in-a-lifetime opportunity. For more insights on maximizing your equity compensation, subscribe to our blog.