In this article on RSUs, we discuss:
How RSUs work
RSUs are a type of equity compensation where individuals own shares of common stock and receive them when certain conditions are met. Typically those conditions are timed based through a vesting schedule and may have an event based condition as well (e.g. the IPO of the company). Unlike stock options, RSUs do not need to be purchased, when conditions are met, they are received at their fair market value (or FMV).
Private company RSUs
If you have RSUs in a private company, the value of your shares is based on the current 409A FMV. A 409A valuation is produced by a third-party appraiser and is meant to reflect the current value of the company.
What are double-trigger RSUs?
A double-trigger provision means that two events need to occur for you to own your shares. Those events are typically:
- Your RSUs vest
- Your company goes through a liquidity event (like an acquisition or IPO)
While this means that you don’t take ownership of your double-trigger RSUs when they vest, it also means you don’t have a tax liability on your shares until your company goes through the second trigger, a liquidity event. We’ll talk more about that later.
Public company RSUs
If you work at a public company, the value of your RSUs is determined differently and you may receive them at different times depending on if your company is in a blackout period. The FMV is determined by the stock price at time of vesting.
If your RSUs vest during a blackout period, they’re only released to you during the next open trading window. For example, if your company has a blackout period from June 15-August 15 and your shares vest during that time, they’ll be released on August 16. That release date will be when they’re reported through payroll and not necessarily on the vesting date.
How are restricted stock units taxed?
There are two taxable events for restricted stock units. The first is upon vesting when your RSUs are subject to the standard income tax. The second is when you sell them, they’re subject to either short- or long-term capital gains tax.
What is the capital gains tax?
Capital gains are the profits made from selling your shares relative to what you paid for them. Those profits are then subject to the capital gains tax. There are two types of capital gains:
Short-Term Capital Gains: These gains are from shares owned for less than one year at the time of sale.
Long-Term Capital Gains: To achieve long-term status, shares must be held for at least one year from the date of exercise.
What are the taxes on capital gains?
Short-term capital gains are typically taxed as ordinary income. Long-term capital gains are taxed at a rate of 0%, 15%, or 20% depending on your taxable income and marital status. Long-term capital gains rates are likely the lowest tax on your company shares. In order to maximize the benefits of your RSUs, it’s typically advisable to hold your shares for a year after the exercise date.
Taxable income from RSUs is considered supplemental wages. As supplemental income, employers withhold at a 22% flat rate for the first $1,000,000 of value to cover taxes. Any excess over $1,000,000 is withheld at 37%. However, it’s important to note that this withholding may not sufficiently cover your tax liability. Depending on your 2021 federal tax bracket you will owe more than 22% starting at incomes over $86,375 for individuals. This means you may owe additional taxes on your RSUs beyond what your employer has withheld.
2021 Federal Tax Brackets
|Tax Rate||Taxable Income
(married filing jointly)
|10%||Up to $9,950||Up to $19,900|
|12%||$9,951 to $40,525||$19,901 to $81,050|
|22%||$40,526 to $86,375||$81,051 to $172,750|
|24%||$86,376 to $164,925||$172,751 to $329,850|
|32%||$164,926 to $209,425||$329,851 to $418,850|
|35%||$209,426 to $523,600||$418,851 to $628,300|
|37%||Over $523,601||Over $628,301|
Source: Internal Revenue Service
Supplemental income impacts
Because you have a taxable event on your RSUs when they vest, your pay statement will include the fair market value (FMV) of vested RSUs as income even if you do not sell. This impacts your taxable income and can increase your effective tax rate. Because of this increased taxable income, it’s important to watch out for:
- Roth IRA phaseout – you may no longer be eligible to contribute directly
- Child Tax Credit phaseouts – this credit is eliminated for joint filers with an adjusted gross income (AGI) of $400,000 or single filers with an AGI of $200,000
Methods to cover withholding tax
Public company employees can utilize a few methods to cover the withholding tax for RSUs. Unfortunately for employees of private companies, your only option is the first on this list – a cash transfer.
- Cash transfer: Use cash to pay the withholding tax (and exercise cost where applicable). With this option, none of your shares are sold.
- Sell to cover: This involves selling vested shares of stock to cover the cost of the withholding tax (and cover the exercise cost where applicable). The remaining shares are given to the recipient. (note: you must sell during open trading windows)
- Same day sale: You can sell all vested shares and use part of the cash proceeds to cover your withholding tax (and exercise cost where applicable). The remaining cash is given to the recipient. (note: you must sell during open trading windows)
Quarterly tax payment triggers
When your RSUs vest, you may be required to make quarterly estimated tax payments to the IRS and state taxing authorities for that income. Quarterly estimated tax payments are typically needed for any non-wage sources of income. However, while RSUs vesting is technically included in your wages, the withholding from our employer may not be sufficient and would result in the need for quarterly tax payments.
With your regular salaried income, your employer already pays estimated state and federal taxes for you. When it comes to other forms of income (like vesting RSUs), there are no automatic estimated payments made. Therefore, on any income potentially subject to the alternative minimum tax (AMT) or if you underwithheld for regular income, you may have to make quarterly estimated tax payments. However, if your regular income tax payments meet the qualifications below, you can delay your tax payments on AMTI until it’s time for your annual tax filing.
How does it work?
To avoid an underpayment penalty, estimated tax payments are based on the lesser of:
- 110% of your prior year tax (called the safe harbor method)
- 90% of your projected current year tax
If your income is less than $150,000, you can use 100% of your prior year tax for safe harbor.
If you use the safe harbor method for all four quarters, it’s important to note there may be a catch-up payment due by April 2022.
Help with understanding RSUs
Whether you are a founder or an early employee at a startup, it’s important that you understand the tax implications of decisions you make today regarding how your company is structured, how and when you’re taxed on stock shares, and when you exercise stock options.
The best approach for each decision may differ based on certain unique considerations (business model, industry, growth plans, personal financial situation, etc.) and an advisor experienced in working with startups and startup employees can offer a lot of interesting insights in to what’s common with other companies, and their recommendations for the tradeoffs you should consider in your particular situation.