You get a grant notice from your employer explaining that you have been or will soon be awarded restricted stock. “This is great!” you think. “Free stock. The chance for some upside if the company does well.” 

But … 

Are they restricted stock units (RSUs) or restricted stock? 

What’s the Difference Between Restricted Stock and Restricted Stock Units (RSUs)? RSUs vs. Stock Options

How Does Restricted Stock Work?

With restricted stock, an employer grants actual shares of stock to an employee with restrictions as to when they may sell or otherwise dispose of the stock. The vesting of restricted stock is typically based on specific performance goals or, more commonly, time worked at the company.

Because restricted stock involves actual shares of stock — the value of which is ascertainable as of the grant date — owners of restricted stock are allowed voting and dividend rights along with the ability to make a special tax election under IRC Section 83(b). 

Consider making a Section 83(b) election within 30 days of receiving a grant of restricted stock. The election will make the value of the stock taxable to you as ordinary income (including Social Security and Medicare payroll taxes) based on the value as of the grant date. This allows for the potential reward of lower capital gains tax rates on the gain after the stock vests and you sell it (assuming that date is one year and a day after the grant date). 

The primary risks are:

1. The stock never vests because you leave the company or the company closes.
2. A significant decrease in the stock price between the grant and vesting/sale dates.

In both risk cases, you end up recognizing and paying taxes on income you never realize later.

Without an 83(b) election, you will pay ordinary income and payroll tax on the restricted stock as of the date the stock vests to you (aka the date it becomes unrestricted). Any gain from that date forward is taxed as a short- or long-term capital gain, depending on how long you own the then-unrestricted stock.

For the restricted stock of a pre-IPO company, the rewards of a Section 83(b) election can be extraordinary … but the risk is significant. 

How Do RSUs Work?

Rather than an award of actual stock, RSUs are a promise to give shares of stock to an employee who meets certain restrictions. At the time of the grant, there are no taxes to pay, no special Section 83(b) election, and no nifty trading strategies to contemplate. Just the company’s commitment.

For these shares to actually come into existence and for you to receive them, you must wait until your RSUs vest. Companies impose different restrictions and requirements on the vesting of RSUs, and your grant agreement will communicate the terms associated with yours. The most common restriction with RSUs is a time commitment: a waiting period during which an employee must continue to work for the company until the shares vest.

These awards exist as a way to promote loyalty and encourage commitment to the overall success of the business. Although they’re more commonly awarded to employees, RSUs are granted to non-employees in some cases as well.

As I previously mentioned, many grants will require that you remain employed or associated through a specific date or dates — sometimes several years — in the future. Other grants will also require you to achieve specific milestones before awarding the actual stock. These specific types of grants are sometimes referred to as performance stock units (PSUs).

Where Can You Get Information About Your Restricted Stock or RSUs?

The main document(s) to help you understand your restricted stock or RSUs are your company stock plan or grant agreement. The latter typically looks like a legal document with provisions, restrictions, and other detailed language along with your signature, accepting the grant.

It’s important to know there’s generally not one universal document if you have multiple types of equity compensation or even multiple grants of the same type of equity comp. If you have multiple awards, you’ll likely have a separate grant agreement for each of your awards, and your employer may implement different features for different equity comp plans. We ask clients to share each separate grant agreement, stock option plan, and other informational documents about their equity compensation plan(s).

Vesting Terms

The single most important part of a grant notice is the vesting terms. You gain control of actual stock once you meet these terms. When you receive actual stock, you are then able to make decisions on whether to hold and/or sell the shares. Vesting terms come in different forms:

• Time-Based Vesting: Under these vesting terms, you will find graded or cliff vesting schedules. Graded vesting means that you receive the stock in installments. For example, you could receive a 1,000-share grant with vesting events where you receive 250 shares of that grant every 12 months for four years. Cliff vesting means that you receive the stock all at once, such as all 1,000 shares after 36 months. 
• Performance-Based Vesting: To incentivize employees to make the company more profitable, some RSU grants and most RSA grants tie the vesting of the awards to measurable metrics of performance. The plan document will show the milestones and formulas that the company considers.
• Double-trigger vesting: Pre-IPO companies that use RSUs will typically grant shares under what’s called “double-trigger vesting.” The first trigger is the more common time- or performance-based vesting, with the second being a liquidity event, like the company being acquired. This solves the issue of illiquid stock being taxable without a means of selling shares to raise cash and/or pay the taxes.

Trading restrictions may also play a role. If the stock involves a publicly traded company, you may be limited to specific timeframes during which you can sell your shares. If these restrictions apply to you, your company will typically share an insider trading policy and may reiterate it in the grant notice.

What Should You Do with RSUs?

When RSUs vest, ask yourself this question: “If this were a cash bonus, would I use it to buy more of this company’s stock?”

If your answer is “no,” consider selling the shares immediately and deploying the cash as you otherwise would in your financial plan. This will limit your investment exposure and avoid a concentrated stock position. If you’ve already found yourself with quite a bit of your company’s stock, check out our blog on how to diversify your stock portfolio.

How Are RSUs Taxed?

Knowing what to do with RSUs has a lot to do with how they’re taxed. When granted, you don’t owe any taxes. Remember, RSUs are a promise that an employer makes to an employee to give them shares of stock when they meet certain conditions. And you can’t be taxed on a promise! If you don’t accept a grant, you’ll never be taxed on your RSUs because you won’t receive any.

If you do accept the grant, you won’t be taxed until you receive the shares. That means no taxation happens after the grant date until vesting. When the shares vest and you receive them, you pay ordinary income tax on their fair market value as of the vesting date. You don’t pay for the shares themselves since you met the conditions necessary to receive them. That was your payment! But you’re not off the hook entirely, since you’ll still pay taxes on them. 

RSUs are considered supplemental income, like a bonus. If you earn less than $1 million in a single tax year, your RSUs are taxed at 22%. Once you hit the $1 million mark in supplemental income per year, that 22% tax rate jumps up to 37%. This is where it can get tricky tax-wise. If your effective tax rate is lower than 22%, you’d get any additional dollars you paid in tax back as a refund when you file your taxes if they’re not used up elsewhere. But if your effective tax rate is over 22%, as it is for many high earners, a tax projection can guide you toward adjusting your tax withholding and/or help you prepare for any balance due at tax time.

Employers will sell recently vested RSU shares to cover the tax withholding. It’s important to note that there’s often a small dip in the stock price versus the price at which the RSU vested because of this tax-withholding selling. Because you’re paying tax on the fair market value of the shares as of the date they vest, your gain or loss at any point thereafter is treated as a short- or long-term capital gain/loss, depending on when you do sell the remaining shares. For these reasons, it’s often the case that the shares sold for tax withholding will provide you with a short-term capital loss.

Remember, those who sell shortly after vesting or anytime prior to holding the RSUs for a year will have a short-term capital gain/loss on any change in the shares’ value after vesting. If you hold your RSUs for more than a year after vesting, you’re now in long-term capital gain/loss territory. This can offer preferential tax rates for those willing to hold out.

Whichever way you go, it’s important to decide when to sell based on your needs and bake your strategy into your financial plan.

How Do RSUs Work in Your Financial Plan? 

We see many clients begin to get top-heavy with their financial net worth tied to their employer’s stock. That’s because grants and vests can pile up over time, leaving them with lots of employer stock. This is where you should start to contemplate your employer’s role in your net wealth. 

Consider this: You already rely on your employer for your income, your employee benefits, and more, so you might not want to rely on them for a large portion of your portfolio, too. You could end up relying on a single employer for too much of your overall financial plan. It’s important to recognize that you can wield complete control over very few parts of that situation. The amount of your employer’s stock that you own is something you can, for the most part, control completely.

How Should You Time Your RSU Sales?

Option 1: Sell immediately.

Some plans allow you to make an immediate and automatic sale after vesting by selecting this strategy ahead of the vesting date. If this option isn’t available, you may have to wait a few days after vesting for the actual stock to post and settle in an account where you can sell it. Be mindful of your insider trading policy: If your goal is to sell immediately, you might have to wait for your next trading window to open.

With RSUs, because you’ve already been taxed at vesting, selling immediately doesn’t change your tax outcome very much, if at all. Different story if you made the 83(b) election on your restricted stock.

Option 2: Hold for more than a year.

Think the stock is going to kick butt? Was your answer to the question, “If this were a cash bonus, would I use it to buy more of this company’s stock?” a strong, “Yes”? Do you have no better alternatives or needs for the stock you receive? Then you might consider holding the stock for at least a year and a day.

When you do this, you’ll receive the benefit of more preferential tax rates at the federal level on any growth in the price of the stock over that year or longer. Since you’ve already been taxed through your 83(b) election or at vesting, remember that you’ll only owe additional tax on the difference between what you sell the stock for and its value when you were taxed.

Option 3: Indecision, aka hold for a year or less.

This probably happens more often without planning but can certainly happen with some planning as well. If you’ve decided to let your stock ride, you may run into a scenario where you need to sell it sooner (as in one year or less after it vested) than later.

If you do sell it within a year, you’ll be subject to additional ordinary income taxes on any growth between the date you were taxed and the date you sell it. Sometimes, however, it’s important to remember not to let the tax tail wag the dog. If you need the cash and this is the place it makes the most sense to get it from — it is what it is.

No matter which option you choose, stay on top of it and keep planning. Overall, keep a detailed track of your positions. We do this for you so that you can visualize your equity compensation in one place, foresee future vesting events, and identify when it makes the most sense to sell your vested positions.

Need to re-up your emergency and future opportunities fund (EFOF)? You can track upcoming vesting schedules for times to replenish your high-yield savings account. Pre-stocking your EFOF might also allow you to commit more of each paycheck to your 401(k) contributions by supplementing your income with cash from your RSU sales.

Instead of generating savings for future financial goals (like a home purchase or college funding), you can coordinate future vesting events with these financial goals. This way, you don’t have to keep too much money in cash, thus exposing your savings to purchasing power risk, aka inflation.

Remember, if your company gave you the option to receive the value of these shares in cash, would you go and purchase more of your company’s stock with that money? If the answer is “no,” you may consider selling your positions to diversify your financial net worth. Just don’t forget to let us know so we can update your financial plan and equity compensation strategy — as well as your tax projection.