Are RSUs taxed twice?

If you work in the Bay Area for a public technology company, as I do, then part of your salary is paid in Restricted Stock Units (RSUs). As part of my FIRE education, I had to learn what RSUs are, how they are paid out, and how they are taxed. In this post, I will explain how RSUs work and how you can maximize their value and save on the taxes when selling.

What is a Restricted Stock Unit (RSU)?

A restricted stock unit (RSU) is often referred to as stock-based compensation. It means that part of an employee’s salary at a public company will be in the form of RSUs. An example would be John Doe receives an offer from Big Public Company that includes a base salary of $100,000 and RSU package for $20,000 that vests over 4 years. Let’s assume the stock price for Big Public Company is $25 per share. Therefore John Doe’s RSU package will grant him 800 shares of Big Public Company stock on the day he starts employment. If the stock price holds constant at $25 for the next 4 years, the value of the RSUs vested per year is $5,000. Therefore, John Doe’s total compensation breaks down to $105,000 per year (base salary + RSU package divided by 4 years).

How do RSUs work?

RSUs provide an employee with equity in the form of company stock. RSUs have no monetary value until the stock vesting date. Upon the vesting date, the RSU will convert to vested shares with a monetary value based on the current company stock price. Silicon Valley companies often use RSUs as a form of incentive for employees to stay with the company longer. Most companies will have vesting dates typically spread out over a 4-year period. The payout amounts and vesting dates will be divided up according to the company’s vesting schedule. For example, some companies follow a vesting schedule such as:

• 1st-year cliff where 1/4 of RSU is paid after 1-year of employment.
• Followed by 1/16th of RSU is paid every 3-months of employment thereafter.

Going back to my example with John Doe, his RSU package will be paid in the following manner:

• Big Public Company stock price is $25 per share for the next 4-years
• John Doe’s RSU package = $20,000
• Shares of stock = $20,000/$25 = 800 shares of Big Public Company stock
• 1st year cliff = 1/4 * 800 shares = 200 shares ($5,000)
• 1/16th payments every 3 months after 1st year = 1/16 * 800 shares = 50 shares ($1,250)

I made the following timeline to help explain the vesting schedule using my John Doe as an example.

Do you get taxed twice on RSUs?

A common misconception is being taxed twice on RSUs which is simply not true. Instead, a better way of understanding the taxation of RSUs is by breaking it down into 2 separate events:

• The first tax event is on the RSU vesting date when the scheduled unvested shares amount becomes vested. Not to be confused with RSU grant date which is not taxed. The RSU vested amount is added to your W2 Form and taxed as ordinary income calculated from the stock price on the vesting date.
• The second tax event is on the date you decide when to sell the RSUs that have vested from the first tax event. If the RSU vested shares are sold at a stock price greater than from the vesting date stock price, then you have capital gains. RSU capital gains are subject to be taxed at either Short-Term Capital Gains or Long-Term Capital Gains.

First RSU tax event

For each vesting date, it is mandatory to pay the first tax event immediately as part of your compensation income. The amount of income is determined by the number of RSU vested shares multiplied by the stock price on that date. For U.S. employees, the RSU income will appear on the W-2 Form. RSU income is subject to the mandatory supplemental wage withholding taxes that include:

1. Federal income tax at the flat supplemental wage rate (22% in 2019)
2. Social Security (up to the yearly maximum) and Medicare
3. State and local taxes (where applicable)

Sell-to-cover First RSU tax event

Upon the RSU vesting date, some RSU stocks will automatically be sold to cover the RSU dollar amount which is taxable income. A majority of tech companies that offer RSUs to employees will automatically pay for the First RSU tax event using Sell-to-cover. My old employer allowed employees to choose how to pay for the First RSU tax event. Deciding to use either salary deductions or Sell-to-cover to pay for taxes so it is worth asking your employer. Sell-to-cover can also be used to raise the necessary funds to exercise an employee stock option.

Second RSU tax event

The second tax event is on the date you decide when to sell the RSUs that have vested from the first tax event. If the RSU vested shares are sold at a stock price greater than from the vesting date stock price, then you have capital gains. These capital gains are subject to be taxed at either Short-Term Capital Gains or Long-Term Capital Gains.

• Short-Term Capital Gains are paid for any RSU profits that are sold where the RSU assets are held for less than 1-year after the vesting date. Short-Term Capital Gains are subject to the tax brackets set forth for ordinary income.
• Long-Term Capital Gains are paid for any RSU profits that are sold where the RSU assets are held for greater than 1-year after the vesting date. Long-Term Capital Gains are subject to 15% tax if your income is between
  • $39,376 to $434,550 (filing Single)
  • or $78,751 to $488,850 (filing Jointly Married)
  • Single filers who make less than $39,376 pay 0% Long-Term Capital Gains tax.
  • Jointly Married filers who less than $78,751 pay 0% Long-Term Capital Gains tax.

2019 Tax Income Bracket for Short-Term Capital Gains and Long-Term Capital Gains

To better help explain the tax differences, I created the following chart which combines the Taxable Income amounts from the 2019 tax bracket with the Long-Term Capital Gain amounts. (Source: IRS).

The following links are also good sources to reference for the same topic:

• https://www.bankrate.com/finance/taxes/tax-brackets.aspx
• https://www.bankrate.com/investing/long-term-capital-gains-tax/
• https://www.nerdwallet.com/blog/taxes/federal-income-tax-brackets/
• https://www.nerdwallet.com/blog/taxes/capital-gains-tax-rates/

Should I sell RSUs immediately?

Selling RSUs immediately would mean the second tax event would occur on the same date as the first tax event which is the vesting date. The RSUs would be subject to the Short-Term Capital Gains tax. However, there would be no change in the stock price because the RSUs vested and sold on the same date. Therefore there would be no capital gains and only the mandatory supplemental wage withholding taxes to pay from the first tax event.

Selling the RSUs immediately is really a choice for the individual person to decide if he/she wants to hold the RSUs because the stock price could increase or decrease. Nobody can really predict the future but one could imagine scenarios where selling RSUs from Google would mean missing out on lucrative future stock gains from 2015 to 2020. However, RSUs from IBM would have lost value due to stock depreciation over the same period.

What happens to RSUs when I quit?

When you decide to quit, the unvested balance of RSU shares will be forfeited back to your employer. The vested balance of RSU shares is yours to keep until you finally decide to sell them as part of the second tax event. The decision that you can control is the official date of when you terminate employment at your employer. After you quit, all future vesting dates that were originally part of your vesting schedule are no longer valid.

In my example with John Doe, he started employment at Big Public Company on January 1, 2019. Let’s pretend after 17 months of employment, John decides to quit on May 1, 2020. John would walk away with only his vested RSU shares. His vested RSU share balance before tax on March 1, 2021 would be 250 shares. The unvested balance of 350 shares would be forfeited back to the company.

Is it better to take RSUs or stock options?

A private or public company can offer employee stock options instead of RSUs. A stock option is a contract that gives an employee the ability to buy shares of their employer’s stock at a certain price, within a certain period of time. It’s called an option because the employee has the option to exercise his right to buy the stock but is not obligated (especially if his/her employer is doing business poorly).

Let’s pretend for example that John Doe was offered 800 shares of stock options instead of RSUs. The stock package is for $20,000 that vests over 4 years. Let’s assume the stock option Strike price for Big Public Company is $20 per share. Here are a couple of scenarios that could happen:

Scenario 1: In-the-Money (ITM)

On January 1, 2020, Big Public Company stock price is $25 per share, therefore 200 shares are worth $5,000. As a result, John could pay $4,000 to buy 200 shares worth $5,000 by exercising his option at the Strike price of $20 per share. This is commonly referred to as “In-the-Money” (ITM). John has to make a decision. This decision becomes harder to make if the company is pre-IPO because the public valuation is unknown. For example, pre-IPO for Uber was $80B in 2019, however, after IPO, Uber stock has performed poorly and currently sits below the $80B valuation (at the time of this writing February 2020).

Scenario 2: Out-the-Money (OTM)

On January 1, 2020, Big Public Company stock price is $15 per share, therefore 200 shares are worth $5,000. As a result, John could pay $4,000 to buy 200 shares worth $3,000 by exercising his option at the Strike price of $20 per share. This is commonly referred to as “Out-the-Money” (OTM). John has to make a decision. Again, this decision is still not obvious if the company is pre-IPO. For example, pre-IPO for Facebook was $100B in 2012 which sounds like a bargain given Facebook is worth $500B in 2020. However, if the company is public, you are not obligated to exercise the option because it would be cheaper to purchase public shares.

Here are some pros and cons for both RSUs and stock options:

Are you a Long-Term investor?

I have always been a Long-Term Capital Gains investor and tend to hold my stocks for well over 1-year. This includes my RSUs as well as my own personal portfolio of stocks.

Does your company offer you RSUs or stock options? How long do you typically hold a stock before selling? Let me know in the comments.

Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services.

RTM RSU Calculator sheet

I created a spreadsheet using my example of John Doe and his RSU package as explained in this post. The sheet will help break down the calculations further in terms of stock units allocated per the vesting schedule and the income taxes due using Sell-to-cover. Free for my readers to download!

RTM RSU Calculator sheet

Understand how Restricted Stock Units are distributed and taxed over 4-year vesting period. Vesting dates are 1st year cliff followed by 1/16th payouts every 3-months.

$3.00

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