In the corporate world, it’s become increasingly common for companies to incentivize employee loyalty by rewarding them with stock. One of the most common forms of equity compensation comes in the form of restricted stock units, otherwise known as RSUs. Because of their increasing popularity, it's important to understand what they are, how they work and their benefits.
What are RSUs?
At their core, RSUs are retention tools publicly traded companies use to attract and keep their top talent. As an employee, you are awarded a certain number of shares of company stock after meeting specific requirements. Once these conditions are met, your shares become vested, and you are then the owner of them. You can hold or sell the stock at any time, with no strings attached.
Typically, you would receive these shares after working a certain number of years for your employer. Let’s say you’ve been granted RSUs, and you decide to make a job change two years before they vest. If you leave that company then, you’ll leave equity on the table.
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Many large companies have valuable stock, which is a significant incentive for people to stay in their current job.
How do RSUs differ from stock options?
While RSUs grant you guaranteed shares that you receive after certain conditions are met, stock options give you the opportunity to buy shares of your employer’s stock at a specified price — aka a “strike price.”
Stock options are typically used by early-stage startups or pre-IPO firms. This gives you the option to buy the stock at lower prices, so if you stick with it, and the company hits it big, you could win big! On the other hand, because they’re not on the public market yet, pre-IPO shares may not carry an accessible value for an unknown period of time.
What are the main benefits of RSUs?
In the past, stock options were one of the most commonly used tools for talent retention and stock awards. But stock options come with a handful of challenges for the person receiving them.
A stock option can be underwater, meaning that its value can decrease by the time it vests. For instance, if your strike price is $50 a share, and the price of that stock becomes $25 a share by the time it is vested, you would end up paying double its face value if you chose to exercise it! For that reason, many companies have moved away from stock options and now use RSUs.
The big difference is that RSUs never go underwater. It’s a gift of stock with no strike price attached to it.
Typically, the number of RSUs granted to an employee tends to be smaller than the number of stock options granted, but as an employee, you have the assurance that they’ll never go underwater. On the day that RSUs vest, you have a set number of shares in your account. The company will sell enough shares to cover the taxes that are due on your RSU. If you were granted 100 shares of RSU, you will end up with fewer shares in your account to cover the taxes due on the grant. You can sell it, keep it or do whatever you want, whenever you want.
What are the tax implications of RSUs?
Whenever RSUs vest, they become taxable income for you. You wind up paying taxes on their cost basis — that is, the market value of those shares on the day you receive them. The cost of these shares will largely determine your tax burden.
For example, let’s say your shares vest at $100 a share, and a year from now, you want to sell your shares, and they’re worth $80 apiece. You could use that decline in value to harvest your losses against any capital gains. On the other hand, if you wait to sell them and they grow to $120 a share, that’s a gain. You’ll pay capital gains taxes on only $20 because you already paid taxes on the $100 when it was vested.
Without a doubt, RSUs can be attractive investment incentives that foster employee loyalty. However, as is the case with any other type of security, you must carefully consider the way they work when you’re devising your overall tax-planning strategy with your trusted financial adviser.
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