You’ve been working hard for some time now, dedicating your valuable expertise to your company, and doing it well. And it shows! Your employer included restricted stock units (RSUs) in your compensation package when they hired you as part of their “attract and retain” strategy, and it looks like it’s about to pay off for both of you.
In order for your RSUs to vest, you have to meet certain time or performance milestones before they become actual shares. You’ve held up your end of the deal, delivering great work over a solid period of time, and now it’s time for you to reap the rewards.
We completely understand the excitement, slightly elevated heart rate, and even the uncertainty you may be feeling. After all, once your RSUs become actual shares, they also become taxable income. This may change things a little or a lot depending on your overall financial situation.
The decisions you make around exercising your RSUs can have a significant impact, and understanding your options is really important. The tax implications alone are a bit convoluted, but don’t worry – we’ve got you covered.
Keep reading for a closer look at how your RSUs are taxed, and some suggestions for what to do with your company shares so that you get the most out of your compensation, keep a diversified portfolio, and avoid an unexpected and unpleasant bill from the IRS.
Details on RSUs
How are RSUs taxed?
Income taxes incurred on vested RSUs are between 22% and 37% depending on your tax bracket. It’s extremely important to make sure your tax withholding is adequate.
Short-term capital gains are incurred on vested RSUs held for less than one year and are taxed at your ordinary income tax rate.
Long-term capital gains on RSUs held longer than one year are eligible for a preferential capital gains tax treatment based on your income and investment gains.
Should I hold or sell my RSUs when they vest?
If you sell your shares immediately, you can keep the cash or purchase other stocks to keep a diversified portfolio. Overall, the tax impact of this strategy will likely be minimal if the stock price has not changed much over the year.
To maximize long-term gains, hold your shares for longer than a year. To avoid concentration risk, you may consider selling other shares to purchase different stock.
You can sell small chunks of your shares over time, preferably on a predetermined schedule in order to balance things out during times of market volatility.
Shares held for more than a year can be transferred directly to a qualified charity, eliminating your capital gains taxes.
RSU tax implications
Knowing what’s what when you hold RSUs as part of your compensation is extremely important to your overall financial well-being, both short- and long-term. With some attention to detail, timing, and a clear understanding of what happens to your tax liability in all scenarios, you can confidently make choices about what to do with your RSUs as they vest.
Income tax vs. capital gains tax in RSUs
Because they are not income yet, RSUs are not taxed until they vest. The value of your RSUs at vesting is what will be taxed to you as income. After the RSUs vest, your company stock price will fluctuate up and down. The difference between what you eventually sell at and what they vested at will be your gain or loss. If you waited a year and a day from vesting to sell your shares, any gains you have will be eligible for the lower capital gains tax rates.
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Tax withholding
Considered supplemental income per the IRS, RSUs are taxed between 22% and 37% depending on your tax bracket. However, your tax bracket could change pretty drastically depending on the number of RSUs you have and the performance of the company’s stock price.
Your company probably sells a portion of your RSUs as a means of income tax withholding. Therefore, it’s super important to know if and how much your company is withholding and make an educated decision about whether to hold back more.
Your RSUs are supposed to be the cherry on top to a sweet compensation deal. Don’t let them leave a sour taste in your mouth because of unforeseen tax consequences. Being proactive about your withholding can avoid any big surprises at tax time the following year.
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Short-term capital gains
Vested RSUs held for less than one year will incur short-term capital gains taxes from the date of vesting until the date of sale, if the stock value increases. These gains are taxed at your ordinary income tax rate. This rate can be substantially higher than long-term capital gains rates, which are taxed at a lower preferential rate. However, if you sell your shares immediately or soon after vesting, the share price likely won’t be too far off from where they vested at, meaning there should be a negligible tax impact.
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Long-term capital gains
If you hold onto your vested RSUs for over a year, they’re then eligible for a preferential capital gains tax treatment of 0%, 15%, or 20% of the appreciated value from the vesting date. The ultimate rate that you’ll pay on the gains will vary depending on your overall income makeup in that given year.
What to do when RSU shares vest: understanding your options
You have several options when your RSUs vest, each with its own set of advantages and tax implications. It’s really important to have a full understanding of your current financial situation and risk tolerance, as well as a good idea of your financial goals.
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Immediate sale
One approach is to sell your RSU shares immediately upon vesting. If you do this, you’ve suddenly got an influx of cash. This may or may not suit your situation. If you don’t need the cash right away, you might consider the purchase of other stock with the profit from the sale. This strategy reduces the risk of developing a concentrated portfolio.
Given that the value of the shares are taxed to you at vesting, and there likely was little movement in the stock price in the short time period you owned the shares, the additional overall tax impact of this strategy is going to be negligible.
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Dollar-cost averaging
With this strategy, you sell your vested RSUs in little chunks over time. Sticking to a predetermined schedule of selling a certain number of shares over specific intervals can take some of the bite out of emotional decision-making and helps balance things out during times of market volatility.
Dollar-cost averaging is a more disciplined approach to selling off shares, so it’s important to note that if your stock has done well you could run into more substantial capital gains taxes on the sale.
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Holding for long-term gains
If you’re in a comfortable financial situation and have a higher risk tolerance, you may choose to hold onto your RSU shares to get those long-term gains. Shares that are held longer than a year before sale qualify for reduced long-term capital gains tax rates. However, this approach comes with increased risk if the stock price goes down during the holding period.
Holding some shares for long term gains and selling others to purchase different stock is a good strategy for diversifying your portfolio and avoiding concentration risk.
If you’re all about being “the change you want to see in the world,” you can donate your RSU shares held longer than a year to charitable organizations. Transferring your stock directly to public charitable organizations or a donor-advised fund eliminates capital gains taxes you would incur if you chose to sell the stock and donate the proceeds.
If you itemize your deductions at tax time, you’re liable to reduce your adjusted gross income (AGI) by 30% for tax purposes. If you ended up donating more than that, the balance can be used on future returns for up to five years.
Final Thoughts
As you prepare for your RSUs to vest, remember that you can make great decisions if you understand a few important details. We recommend you thoroughly review your grant document. It contains all of your RSU information, including the grant price, vesting date(s), and withholding information.
Most importantly, know when your RSUs vest and have a plan in place before then.
Vesting events are exciting, for sure, but they can lead to some uncertainty and emotional behavior. Finding the middle ground between treating yourself and maintaining a healthy financial approach is key. To avoid reactionary decisions, consider consulting with a qualified financial planner or tax professional. This can be helpful in making informed, long-term decisions so you can maximize your income instead of forking a hefty chunk over to the IRS.
At SK Wealth, our financial advisors have been helping our clients make informed choices regarding your stock-based income and how to plan for 25 years. We’ve honed our financial planning process, The Integrated Financial Advantage™, in order to offer recommendations that are personal to you, your lifestyle, and your goals so that you can live with intention, tomorrow and today.
