Equity compensation helps with giving employees some incentive that aligns with company goals. It gives the employee a bit of ownership in the company. The method of compensation can vary, and we’ll be going over two of those methods here: restricted stock units (RSUs) and restricted stock awards (RSAs). This post takes the perspective of “you” as the employee.
RSUs are promises of shares of stock to an employee. They granted to you by the employer, and you receive actual shares at a set frequency called a “vesting schedule.” For example, your company may offer you 1,000 shares in company stock over 4 years, to be vested at 250 shares each year.
When RSUs vest, it gets counted as ordinary income for that year. You’ll see it on your W-2 and pay income taxes on it. For this reason, some companies will withhold a portion of the vested RSUs to pay the taxes (otherwise you’ll have to pay them out-of-pocket).
If you decide to hold onto the stock after vesting, your taxable cost basis will be the fair market value (FMV) at the time of vesting. Holding for ≤ 1 year will result in short term capital gains; holding for > 1 year will result in long term capital gains.
RSAs are actual shares of company stock that an employee receives upon the company granting them. The grant usually (but not always) involves the employee purchasing the shares at FMV.
These shares are also subject to a vesting schedule. The company is able to repurchase the shares if you do not meet the vesting requirements.
There are two paths here:
1) File 83(b) election within 30 days of shares being granted.
This election allows you to pay for any taxes due upon granting. If you use after-tax dollars to purchase at FMV, then there are no taxes due. Any discount, and you pay ordinary income taxes on the discount from FMV.
With this election, no taxes are due upon vesting (you already paid all owed ordinary income taxes upon granting). When you eventually sell the stock, you owe capital gains tax on the difference between the FMV at sale and FMV at granting (the cost basis). Additionally, the holding period for capital gains begins at grant rather than vesting.
Go this route if you’re bullish on the stock. Price appreciation between granting and vesting goes from being taxed as ordinary income to taxed as capital gains.
2) Do not file 83(b) election.
If you forgo the 83(b) election, ordinary income taxes are due at vesting. These taxes are applied to any appreciation over what you paid for the stock. For example, if you purchased at $1/share at granting and the price is $5/share at vesting, you owe ordinary income tax on $4/share.
If you decide to hold onto the stock after vesting, your taxable cost basis will be the FMV at the time of vesting. Holding for ≤ 1 year will result in short term capital gains; holding for > 1 year will result in long term capital gains.
Go this route if you’re bearish on the stock and purchased at a discount. If the stock declines in value, then you’d be paying less ordinary income taxes at vesting than at granting.
If you are being compensated with RSUs, there is only so much you can do in mitigating the tax burden at vesting. Isaac Presley, with Cordant Wealth Partners, discusses a method by simultaneously selling the vested stock and contributing to a pre-tax retirement account (e.g., tradition 401(k), traditional IRA, etc.). The deduction you receive from the contribution can help offset the tax burden of the RSUs vesting.
If you are being compensated with RSAs, then the 83(b) election should be strongly considered.
Ultimately, talk to a tax professional when planning for your specific scenario. The intent of this post is help your understanding when having that conversation.
References
Equity Compensation: Quick-Start Guide to Plans and Benefits, by Tiffany Lam-Balfour, Nerdwallet
The Overlooked Power of Stock-Based Compensation, with Brian Feroldi, Afford Anything (Audio)
Restricted Stock Unit (RSU): How It Works and Pros and Cons, by Jason Fernando, Investopedia
RSU Taxes Explained + 4 Tax Strategies for 2023, by Isaac Presley, Cordant Wealth Partners
RSA vs. RSU, Carta
Restricted Stock Awards (RSAs), Fidelity
83(b) election: Tax benefits and how to file, Carta
Section 83(b) Election – Traps for the Unwary, by Taimoor J. Choudhry, Morse
