Restricted Stock Units Made Simple (Part 2): Taxation
Restricted stock units (RSUs), the unidentical twin of restricted stock, have become the more popular of the two for broad-based grants to employees at many companies. Part 1 of this article series introduced the basic features of RSUs. This article discusses their taxation, which generally resembles that of restricted stock but carries some important differences.
For additional details on RSUs and their taxation, you will also want to read the FAQs in the section Restricted Stock Units. (After you have read this article series and the FAQs, prolong the fun by taking our quiz on RSUs.)
Similar But Different
Just as grants of RSUs differ in a few significant ways from restricted stock grants, the taxation of the two is similar in effect but has important distinctions.
Different Sections Of The Tax Code
RSUs are governed by a different section of the Internal Revenue Code than restricted stock. Unlike with restricted stock, where shares are actually issued at grant, restricted stock units involve no transfer of property when they are granted (this helps them avoid taxation at grant in most countries). Standard RSUs are just an unfunded promise to issue a specific number of shares (or a cash payment) at a future time once vesting conditions have been satisfied—in short, they are nothing more than a corporate bookkeeping entry.
Therefore, with RSUs you do not have any property that is subject to a substantial risk of forfeiture, which is taxed under the rules of Internal Revenue Code Section 83. Rather, RSUs fall under the mantle of IRC Section 451, which recognizes taxable income only upon the actual or constructive receipt of property. Thus, with RSUs you are taxed at vesting and when you are physically given the shares (though usually these events are simultaneous).
No 83(b) Election For RSUs
So if you have RSUs, the good news here is that you do not need to know anything about the complexities that can be involved in deciding whether or not to make the 83(b) election. Let's move gratefully on.
Tax Treatment of RSUs
Under broad-based RSU plans, the delivery of shares, and the corresponding taxation, almost always occurs at vesting. Your taxable income is the market value of the stock at that time, minus any amount paid for the stock. You have compensation income subject to federal and employment tax (Social Security and Medicare) and any state and local tax. It is then subject to mandatory supplemental wage withholding. For further details about tax withholding, see the relevant FAQ.
At vesting, companies tend to automatically withhold shares for the taxes (restricted stock plans are more likely to give you withholding choices). When you eventually sell the shares from an RSU, you recognize capital gains on the difference between the sale price (after commissions) and your tax basis.
Example of the RSU life cycle: Your company grants you 10,000 RSUs. At vesting, when the shares are delivered to you, the stock price is $25. You have $250,000 ($25 x 10,000 RSUs) in compensation income, which will appear on your W-2. Your company automatically keeps 2,500 shares for withholding taxes as part of its mandatory share surrender. Three years later, you sell the remaining 7,500 shares at $40 per share after commissions. You have long-term capital gain for each share of $15 ($40 net sales proceeds minus $25 tax basis). See the section Reporting Company Stock Sales in the Tax Center for annotated examples of the tax return reporting.
|Number of RSUs granted||10,000|
|Value at vesting||$25 per share ($250,000)|
|Shares surrendered for taxes at vesting||2,500|
|Value of remaining 7,500 shares at sale||$40 per share ($300,000)|
|Long-term capital gain||$15 per share ($40 minus $25 tax basis), or $112,500|
Taxation Of Dividend Equivalents
When dividend equivalents are paid at vesting through additional shares or cash, you report these as part of your ordinary W-2 compensation income at that time (unless any deferral election is allowed and made). If this cash-dividend payout occurs earlier, you will be taxed at that time.
You have a few straightforward decisions to make with RSUs. The lapse election is the method by which you choose how to pay taxes at vesting (unless your plan automatically withholds shares to pay taxes) and what will be done with the shares when they vest. The "lapse" is the end of the restriction that prevented the shares from vesting and being transferred. You need to make this type of election before the shares or cash proceeds are released to you. (Not all companies, brokers, and transfer agents call this a lapse election.)
The concept of the lapse election is still evolving as the use of RSUs grows. The specifics depend on your company's plans and procedures. Some companies require you to make this election at the time you accept the grant, while other companies send you the election form during the month before vesting (or earlier). The election can have multiple parts for the taxes and for the proceeds (whether cash or shares).
Depending on the provisions of your RSU plan, your choices for the tax withholding may include the following:
- paying cash (you may have additional choices of paying by check or salary deduction)
- selling or holding back shares to cover taxes (an actual sale of vested shares, or a surrender of shares back to the company, that equals the amount of taxes needed for withholding)
- selling all shares (taxes are withheld from the proceeds)
- selling X number of shares after taxes are covered (selling the amount of shares needed to cover the withholding, plus an additional number of shares)
As mentioned above, some companies automatically use share surrender to cover the taxes, without offering a choice, or make it the default if another choice is not selected.
Below are your choices for holding or distributing the shares or cash proceeds (your company will not get involved with these personal decisions).
- Whether to keep the shares with the brokerage firm or the transfer agent that the company used to handle the transaction, or whether to send the shares to another account elsewhere.
- Whether to keep the sale proceeds with the brokerage firm or the transfer agent that the company used to handle the transaction, or where (e.g. bank or brokerage) to send the check for the proceeds.
Taxation After Deferral Of Share Delivery
Depending on how the RSU plan is structured, share delivery can be arranged to occur at a date after the vesting date, either by your choice or the company's requirement (e.g. when you retire). This deferral of share delivery delays the ordinary income tax. Social Security and Medicare taxes (FICA) may not be deferred beyond vesting, unless there is a substantial risk of forfeiture (see Section 3121(v)(2) of the Internal Revenue Code). When the stock is eventually delivered, you recognize ordinary income based on the value of the stock at that time without any additional FICA tax. RSUs with a tax-deferral feature are more common for executives and directors than for lower-level employees, and they can raise complexities by being a form of nonqualified deferred compensation. For the details, including the stringent Section 409A rules that affect the timing of your elections for deferrals and share distributions, see a related FAQ.
Don't Forget To Think Ahead To Sale
When you eventually sell the shares you receive from RSUs, you will have either a capital gain or a capital loss according to the change (up or down) in the stock price since vesting. You will need to report this on IRS Form 8949 and Schedule D of your Form 1040 tax return. For details about the reporting, including annotated diagrams, see the relevant FAQ in the Tax Center.