As the saying goes, there’s no such thing as a free lunch.
This holds true for a popular employee incentive: restricted stock units (RSUs).
While RSUs can be a boost to your portfolio (and your net worth), there are strings attached. First, you likely have to stay with your company for at least a few years to “unrestrict” all of shares. Second, you need to be wary of taxes.
In this article, we’ll cover what RSUs are, how they work, when they’re taxed, and the steps you can take to minimize the tax consequences and make the most of your stock compensation.
What Are Restricted Stock Units (RSUs)?
RSUs are a common type of equity compensation through which an employer promises to give you shares of company stock, assuming certain conditions are met (known as vesting requirements). They do this through a “Grant”, this grant document outlines all of the details of the vesting requirements. It is key to note, you have no ownership of the shares upon this grant, only upon vesting.
Until they vest, RSUs hold no immediate financial value and cannot be sold or transferred. Fortunately though, unlike stock options, RSUs don’t require any upfront purchase — you simply need to meet your vesting requirements to receive your shares.
Vesting is the process of gradually earning ownership, often by staying with the company or meeting performance milestones. The vesting schedule for your RSUs will be explicitly outlined in your grant documents, but you can expect one of the following methods:
- Cliff vesting: All shares vest at once, after a fixed vesting period (e.g., four years with the company).
- Graded vesting: Shares vest in increments — such as 25% annually for four years.
- Hybrid vesting: This is a blend of cliff and graded vesting. For example, 25% of your RSUs could vest after one year, while the remaining shares vest in equal, monthly lots over the subsequent three years.
That said, if you work for a private company that intends to go public, your RSUs might require a “double trigger” to fully vest. In other words, you may have to meet a time-based requirement and wait for a liquidity event (such as an IPO) to receive your shares.
This could lead to a materially longer holding period. This double trigger is helpful to non-public company employees, as it delays a taxation event to a point where shares could be sold to pay for the tax burden of the vesting.
Once vested, RSUs turn into actual shares that you own outright, but they also become subject to tax considerations.
How Restricted Stock Units Are Taxed at Vesting
RSUs are taxed as ordinary income when they vest. So, if your shares vest in four installments over four years, that means you’ll owe taxes on your RSUs each year.
The taxable amount is based on the fair market value (FMV) of the stock on the vesting date. For instance, if 1,000 of your RSUs vest today, and the FMV is $30 per share, then $30,000 is added to your income for the year. For tax purposes, this is essentially like receiving a $30,000 bonus in cash, except it’s in company stock.
That’s fairly straightforward, but there’s another wrinkle to consider: the process to actually pay the tax!
RSU Tax Withholding
RSUs are a form of supplemental income. The IRS mandates a 22% withholding rate for supplemental income up to $1 million.
There are several ways to manage this liability:
Sell-to-Cover: This is the default method for handling taxes on vested RSUs. In this approach, your employer automatically sells a portion of the vested shares, usually assuming a 22% withholding rate. For instance, if you have 100 shares vesting, your employer might sell 22 of these shares to cover your tax obligation. This typically covers federal, state, and payroll taxes.
Withhold-to-Cover: Rather than selling shares, your employer could choose to retain shares and pay the exact tax liability with cash on hand. This can help avoid overselling or underselling shares that can happen with Sell-to-Cover, as many brokerages don’t allow fractional sales. For example, if you need to withhold $100 for taxes and the current share price is $90, then 2 shares may need to be sold.
Same-Day Sale: Upon vesting, you could elect to sell all vested shares immediately. This method not only covers the tax liability but also converts all your shares to cash, which could be particularly useful if you need the cash or are already overconcentrated in you employer stock.
Cash Payment: If you believe in the company’s long-term strategies and prefer to hold your vested shares, your employer may allow you to pay the withholding tax with cash. This requires you to have sufficient liquidity on hand to cover the tax bill, which can be significant depending on the number of shares and their market value.
Each of these strategies has its benefits and trade-offs, and the best choice depends on your financial situation, market conditions, investment strategy, and overall portfolio allocation.
It’s important to note that the default withholding may not fully cover your tax obligation. You could owe more (potentially a lot more) beyond what’s initially withheld. If you know this applies to you, consider setting aside funds or selling additional shares as they vest.
How Restricted Stock Units Are Taxed at Sale
Once your RSUs have vested and you decide to sell them, any profit you make from the sale is subject to capital gains tax. This tax rate depends on how long you've held the shares after they've vested.
- Short-term capital gains: If you sell your RSUs within a year of vesting, any profit is taxed at the same rate as your ordinary income.
- Long-term capital gains: If you hold your shares for more than one year after they vest and then sell, your profit is taxed at the long-term capital gains rate, which is lower than the ordinary income tax rate for most taxpayers.
To put this in context though, let’s assume you have 1,000 RSUs that vested exactly 11 months ago; at that time, the stock price was $50 per share. If you sell those shares today for $70 each, the profit of $20 per share ($20,000 in total) will be taxed as ordinary income. \
If you wait another month + a day, your profit would be taxed at the long-term capital gains rate (0%, 15%, or 20% as of 2025).
RSU Tax Strategy
Needless to say, the extra month in this particular situation could provide sizable tax savings, assuming the stock price holds steady. However, volatility is an equally important factor — single stocks are often prone to price fluctuations, so waiting could erase the tax benefits if the stock price declines.
For most employees, selling RSUs as they vest and diversifying the proceeds into a broader portfolio offers the most secure and tax-efficient strategy — because capital gains would be negligible if sold immediately. However, if you believe in your company’s growth and want skin in the game, we recommend limiting your exposure to no more than 10% of your portfolio.
Key Factors to Consider When Managing RSUs
RSUs don’t have exercise prices or purchase requirements (like NSOs and ISOs), so they aren’t the most complicated form of equity compensation. But they aren’t cookie-cutter either — there can be unique conditions and considerations, especially if you work for a private company with public aspirations or unusual vesting scenarios.
Let’s review a few things to keep in mind as you explore your options.
RSAs and 83(b) Elections: If you have Restricted Stock Awards (RSAs), you might have the opportunity to elect for an 83(b) tax treatment. Making an 83(b) election allows you to pay taxes on the fair market value of the stock on the grant date, rather than at the time of vesting. This could reduce your tax liability substantially if the stock appreciates over time. This does NOT apply to RSUs however.
Impact on Tax Bracket: The value of RSUs as they vest can materially affect your taxable income, potentially pushing you into a higher tax bracket. This is something you should plan for when you’re granted shares, so you don’t stumble across tax surprises down the road.
Vesting Triggers: If you work for a startup or a private company, your RSUs may be subject to double-trigger vesting, which likely hinges on public offerings or other exit events. This can result in a large, unexpected tax event if your shares appreciate significantly in the process.
Your Equity Compensation Has Tax Implications: A Strategy Can Help
If you're at a point in your career that you're receiving restricted stock or other forms of equity compensation, it's very likely you could benefit from wealth management. Tax professionals and financial advisors well-versed in equity like the team at Plancorp can help you look ahead to incorporate, diversify, and maximize your earning potential.
RSUs aren’t a free lunch, but they are a compelling incentive that can seriously boost your portfolio and overall financial plan when properly managed. If you're looking to make informed decisions around your equity to maximize it's impact, professional guidance is key.
We’d be happy to help build RSUs into your overall financial plan. Schedule some time with a member of our team to start making the most of your equity compensation.
