When it comes to employee compensation, one size rarely fits all. Companies often customize equity awards to align with their goals and incentivize employee performance. For many, this means one of a few popular options: stock options, Employee Stock Purchase Plans (ESPPs), Restricted Stock Units (RSUs) and Restricted Stock Awards (RSAs).
Today, our focus is on the latter two.
While RSUs and RSAs sound similar, they have distinct differences in structure, tax treatment, and flexibility. In this article, we’ll examine these differences and help you understand how each can fit into your financial plan.
One of the most common forms of equity compensation, RSUs grant key employees a greater personal stake in their company’s success in the form of equity. RSUs are, in effect, a promise — your employer commits to giving you shares of stock in the company once certain milestones are achieved.
RSUs are often favored by mature companies, whereas startups and younger firms will often favor stock options or RSAs. That’s because these options often require upfront purchases (hence you have the option to buy shares at a specified price), which could hinder employee participation if the purchase price or strike price is too steep.
On the other hand, RSUs don’t require you to buy shares at all. Instead, they automatically convert into actual shares when they vest, making them more accessible and straightforward.
RSUs follow a vesting schedule, which outlines when you earn ownership of your company shares.
For instance, if you’re granted 1,000 RSUs with a four-year graded vesting period, you’ll receive 250 shares each year as you hit vesting milestones. This structure encourages employees to stay with the company, as you usually forfeit the unvested shares if you leave before the vesting milestone.
Once RSUs vest, their fair market value (FMV) at that time is treated as ordinary income for tax purposes. For example, if your company’s stock is worth $50 per share, the vesting of 250 shares would add $12,500 (250 shares x $50) to your taxable income for the year.
But that’s not the end of the story. When you sell your vested RSUs, any share price increase is subject to capital gains tax, and any decrease is considered a capitol loss. Let’s say you sell the 250 vested shares a year later at $60 per share. In this case, you’d trigger a $2,500 long-term capital gain (250 shares x $10 profit per share).
There are unfortunately a lot of myths about RSUs that may sway you to make uninformed decisions to hold or sell without knowing the full impact. As such, it’s important to understand the tax treatment and vesting conditions of your RSUs so that you can plan accordingly.
RSAs offer employees a more immediate form of equity ownership compared to RSUs. With RSAs, you receive shares of company stock upfront. While you typically don’t have to pay for these shares, some companies may require employees to pay a nominal amount or the FMV of the shares at the time of the grant.
Although you receive shares right away, RSAs are still “restricted.” Even though your RSAs have restrictions against selling, they often do give the recipient any associated voting rights or dividends that you wouldn’t be entitled to with an RSU grant until after vesting. And like RSUs, the removal of these restrictions are usually tied to time-based requirements to encourage employees to remain with the company and meet certain milestones.
Startups and early-stage companies usually favor RSAs, as lower stock prices and greater growth potential make them a tax-efficient way to incentivize employees. Additionally, employees can gain voting rights and could even receive dividends, regardless of whether their shares have fully vested.
RSAs differ from RSUs in both tax treatment and timing of ownership. One key distinction is the ability to file an 83(b) election, which can significantly affect how and when your RSAs are taxed. This election must be submitted in writing to the IRS within 30 days of the RSA grant date.
If you don’t file an 83(b) election, you’ll recognize your RSAs as taxable income as they vest — similar to RSUs.
If you file an 83(b) election, you choose to recognize the FMV of the shares at the time of the grant (minus any amount you paid for them) as taxable income. For example, if you’re granted 10,000 RSAs valued at $1 per share and don’t have to purchase the shares, you’ll report $10,000 as taxable income in the current year (10,000 shares x $1 per share).
If shares rise to $5 by your vesting date, the 83(b) election allows you to avoid paying ordinary income taxes on the $40,000 increase (10,000 shares x $4 per share price increase). Instead, this amount will be taxed as a long-term capital gain when you sell your shares, assuming you hold them longer than one year. That’s because filing the 83(b) election starts the holding period for the shares at the grant date, not the vesting date.
There are risks to this election though: if the value of the shares falls or if your RSAs fail to vest, you could end up paying taxes on income you never fully realize.
RSUs and RSAs are both common forms of equity compensation but differ in structure, taxation, and ownership. To illustrate, let’s follow two employees at TechCo:
At grant, TechCo shares are worth $1 per share. Here’s how their equity compensation plays out:
RSUs: Alex’s RSUs follow a four-year graded vesting scheduling, with 2,500 shares vesting each year.
RSAs: Jordan’s RSAs shares follow the same four-year graded vesting schedule and remain “restricted” until they vest. Jordan holds actual shares from day one, but can’t sell unvested shares.
RSUs: Alex’s vested shares are taxed as ordinary income each year, based on their FMV at the time of vesting. For simplicity, we’ll assume the company’s stock price jumps to $5 per share in the first year and holds steady. That translates to $12,500 of taxable income each year ($5 x 2,500 shares) — or $50,000 in total over four years.
RSAs: Since Jordan filed an 83(b) election, he immediately recognizes $1,000 of taxable income (1,000 shares x $1 per share) upon the grant date. Because the stock appreciates to $5 by the time it vests, Jordan avoids paying ordinary income taxes on the $40,000 increase and, instead, gets subjected to capital gains taxes on this amount upon selling the shares.
Let’s assume both Alex and Jordan sell their vested shares five years after grant at $6 per share. (We’ll also ignore any state or employment taxes.)
|
RSUs (Alex) |
RSAs (Jordan) |
|
|
Granted Shares |
10,000 RSUs |
10,000 RSAs |
|
Total Taxable Ordinary Income |
$50,000 over four years |
$10,000 with 83(b) election |
|
Total Sale Proceeds |
$60,000 (a $10,000 gain) |
$60,000 (a $50,000 gain) |
|
Federal Income Taxes Paid (35% tax rate) |
$17,500 |
$3,500 |
|
Capital Gains Taxes (20%) |
$2,000 |
$10,000 |
|
Net Proceeds |
$40,500 |
$46,500 |
RSUs: Alex has no ownership rights, voting privileges, or dividend eligibility until the shares vest and convert into company stock. If Alex leaves TechCo, any unvested RSUs are forfeited entirely. For instance, if Alex departs after two years, only 5,000 of the 10,000 RSUs will have vested, and the remaining 5,000 will be lost.
RSAs: Jordan, on the other hand, becomes a shareholder immediately upon receiving the RSA grant, potentially with voting rights and eligibility for dividends. However, if Jordan leaves TechCo before completing the four-year vesting schedule, any unvested shares are typically forfeited. If he had purchased his RSAs upfront, the company may have the right to repurchase the unvested shares.
RSUs: RSUs can be better suited for employees at larger, more mature companies with high stock prices. Since RSUs don’t allow for 83(b) elections, there’s no taxation at grant, reducing the risk that employees pay taxes on an amount higher than the value they are able to realize.
RSAs: RSAs and the 83(b) Election can be advantageous in early-stage companies with lower stock values. The upfront tax impact is minimal or none, and the potential for all growth to be exposed to capital gains vs. ordinary income brackets if the stock performs well is tremendous. That said, this approach involves more risk — if the company underperforms or the shares fail to vest, employees could lose money paid in taxes or their initial purchase costs. Sort of like going all-in in a game of poker before seeing the cards from the dealer, you might have a strong initial position but ultimately you are taking a big risk on the unknown future.
|
Restricted Stock Units (RSUs) |
Restricted Stock Awards (RSAs) |
|
|
Issued |
Shares issued upon vesting |
Shares issued at grant |
|
Purchase Price |
None, but should consider withholding tax |
Typically none, but potentially the FMV of the shares |
|
Vesting |
Time-based or performance-based milestones |
Time-based or performance-based milestones |
|
Tax Treatment |
Treated as ordinary income upon vesting; any profit is subject to short-term or long-term capital gains taxes upon sale |
Taxed at grant or vesting, depending on 83(b) election; any profit is subject to short-term or long-term capital gains taxes upon sale |
|
83(b) Election |
Unavailable |
Optional |
|
Early Termination |
Unvested shares are forfeited |
Unvested shares are forfeited or repurchased by the company |
Both RSUs and RSAs are potentially potent tools for wealth creation, enabling you to benefit directly from your company’s growth. As your company’s stock value rises, so does the value of your equity compensation.
RSAs may provide an added advantage if you leverage an 83(b) election to lock in a capital gains tax rate on future profits (versus an ordinary income tax rate), assuming the company achieves sustainable growth. This strategy can be especially impactful at startups or companies with high growth potential.
Equity compensation aligns your personal financial success with your company’s performance. Whether through RSUs or RSAs, you benefit if the company meets strategic objectives, successfully expands operations, or boosts profitability. This can create a sense of shared ownership and accountability.
RSUs and RSAs provide flexibility to meet varying employee and employer needs. Vesting schedules can be tailored to align with time-based milestones, performance goals, or other strategic targets.
RSAs, in particular, provide unique customization opportunities through the 83(b) election, allowing employees to pay taxes upfront on the grant value and potentially reduce their overall tax burden.
Although this article is focused on how to successfully manage RSUs and RSAs as an employee, it is worth briefly noting why employers opt to compensate in this manner at all given it is several layers more complex than simply paying a salary.
The brief explanation comes down to the ability to attract top talent through increasing pay/incentives while tying it to tenure or performance to ensure results are driven. Although availability of equity compensation may vary depending on where you work, it’s generally a sign that you are on a positive career trajectory and should be considering various ways to optimize your financial plan to make the most of it.
In all likelihood, your equity management isn’t as straightforward as Alex’s and Jordan’s generalized scenario — there are variables like market conditions, tax implications, sale timing, and personal financial goals to consider. Not to mention that RSAs and RSUs could expose you to single-stock concentration risk.
Regardless of the type of equity compensation you have, planning is pivotal. Whether you’re deciding when to sell shares, filing an 83(b) election, or structuring equity packages for your team, the right guidance can make all the difference.
Consulting with a financial advisor on your equity compensation management and integration into your overarching financial plan is key. Ready to dive in and supercharge your wealth building journey with strategic equity compensation management? Book a call with our team today.