What Are Restricted Stock Units (RSUs)?
Restricted stock units (RSUs) are a form of employee compensation where an employee is granted stock from a company. Restricted stock units have a grant date, but will not be owned by the employee until sometime in the future when they become fully vested.
RSUs fall underneath the restricted stock umbrella, and differ from restricted stock awards (RSAs) because the employee does not own the stock immediately after the grant.
Restricted stock units are also different than employee stock options primarily because the employee does not need to purchase the stock in the future. RSUs become owned by the employee once they vest.
Here is an article about restricted stock.
Restricted Stock Units vs. Stock Options
Restricted stock units are different than employee stock options for two primary reasons:
Difference 1: Restricted stock units are owned by employees once vested
Like stock options, restricted stock units have a vesting schedule that is either time-based, milestone-based, or a combination of both. Once the RSUs have vested, the employee owns the stock outright.
Stock options are different because they simply give the employee an option to purchase the stock at an exercise price, or strike price, which was set at the time of the options were issued.
Here is an article on incentive stock options.
Difference 2: Stock options can have preferential tax treatment
Restricted stock units are owned by the employee once vested and are taxed at the ordinary income rate. Incentive stock options, however, can be taxed at the capital gains rate if the employee complies with the qualifications.
Here is an article on incentive stock options.
Given the difference between the ordinary tax rate and capital gains rate, this can make a big difference in tax liability. RSUs, however, can be taxed at a capital gains rate, but only if the employee holds on to the shares, they appreciate, and then sells them.
For example, if an employee is granted $5,000 worth of RSUs, holds on to them and sells them once worth $6,000. The employee would need to pay ordinary tax rates on the $5,000 and capital gains rates on the $1,000 ($6,000 - $5,000).
How Restricted Stock Units Work
Restricted stock units are essentially a stock grant to an employee from a company in the form of compensation. They are called ‘restrictive’ because the employee does not immediately own the stock when the grant is made. Rather, the employee needs to fulfil certain achievements.
RSUs have a vesting schedule which is typically tied to time, milestones, or both. Once the RSUs are vested, the employee owns the stock.
Vesting and Restricted Stock Units
Employees will need to achieve certain criteria in order to earn the ownership of the RSUs. Vesting is a legal term that means to gain a right to a present or future payment. In this situation, when an employee meets their vesting obligations, they earn the right to their shares.
There are three different types of vesting:
- Time-based Vesting: Time-based vesting is when an employee needs to stay with their employer for a certain amount of time in order to earn their shares. For time-based vesting, you will often see a ‘one-year cliff' which means, if an employee leaves before one year, they will receive no shares. Once they achieve the first year, then shares typically vest quarterly or monthly.
- Milestone-based Vesting: Milestone-based vesting is different than time, since an employee will earn the right to their shares after they complete certain value-creating achievements.
- Hybrid Vesting: A hybrid vesting schedule is a mix of both time and completing value-creating achievements.
Here is an article on vesting stock.
Restricted Stock Awards (RSAs)
Another form of restricted stock is called restricted stock awards, or RSAs. RSAs are also not stock options and differ from RSUs primarily because the employee owns the shares when granted the RSAs.
On a high level, RSAs are shares given to employees without any sort of vesting schedule. Since the employees own the shares immediately, they also gain voting rights.
The Difference between RSUs and RSAs
RSUs and RSAs are two types of restricted stock that have many similarities. Below are the main differences:
- RSAs are owned by the employees when they are granted. RSUs typically have a vesting scheduled tied to time or milestones.
- RSUs do not give employees voting rights immediately. Since RSAs are owned by the employee when granted, they immediately gain voting rights.
Here is an article on further differences between RSUs and RSAs.
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Selling Your Restricted Stock Units
Restricted stock units are regulated by the Securities Exchange Commission (SEC) since they are typically given to executives that have inside information about a company. Thus, they are subject to insider trading laws. It is important to follow the right steps to sell your RSUs.
Below are some general steps you can take when selling your restricted stock:
- Step 1: Understand the SEC holding period requirements.
- Step 2: Comply with federal reporting obligations.
- Step 3: Be mindful of the amount of stock you can sell within a certain window of time.
- Step 4: Remove the stock legend.
- Step 5: Execute a normal brokerage transaction.
- Step 6: Get in touch with SEC with required filing.
Here is an article on how to sell restricted stock.
Restricted Stock Units and Tax
Restricted stock units are taxed differently than stock options. For stock options, tax liability is triggered when the options are exercised. For RSUs, tax liability is normally triggered when the shares vest.
RSUs are taxed at the normal income rate when vested. In other words, if you receive RSUs worth $10,000 and they fully vest, the value of the shares ($10,000) will be taxed at the ordinary income rate. If you choose to liquidate some stock but hold some stock as well, then you may need to pay capital gains tax on the profit gained by holding onto the stock.
Here is a link to an RSU tax calculator.
Are RSUs taxed twice?
Many people think RSUs are taxed twice. While RSUs can appear to be taxed twice, they actually are not. In short, once RSUs vest, you owe ordinatry tax on the value of the vested shares. If you choose to hold on to the shares (not sell them), then you may be taxed on the profit you earn if they shares go up before you sell them.
In other words, if your RSUs vest and are worth $5,000. Your tax liability will be fore $5,000 of income and will be taxed at the ordinary income rate. Let’s say you sell $2,000 worth of stock to help pay taxes and hold onto $3,000. If you sell the stock one year from now and the stock increased to $3,500, you made a profit of $500 and will only pay capital gains taxes on the $500.
Given the $500 was not part of the initial RSUs, you will not be paying tax twice.
Here is an article on restricted stock and taxes.
Getting Help With Restricted Stock Units
Restricted stock and other employee stock purchase plans are complicated. If you need help, post a project on ContractsCounsel’s platform to find a lawyer to review your stock-based compensation agreement.