Simply said: With RSUs, you are taxed when your shares vest.
The amount subject to taxation is the value of the shares when they vest.
Unlike stock options, which can become worthless if the stock price decreases, RSUs always retain some value, even if there is a substantial decline in the stock price.
But how do taxes work when it comes to RSUs?
When RSUs vest, this value is treated as income – just like you earned it as salary. If your vesting portion was 400 shares and the stock price $25, then you’ll be assessed tax on $10,000. It will be subject to taxation just like $10,000 of your salary – it’s subject to federal and employment tax (Social Security and Medicare) and any state and local tax.
The amount of tax owed will depend on your marginal tax bracket, and this determined by your household income. If you are married and earn $150,000, then the taxes owed on this RSU vesting will be less than if you are single and earning $300,000.
But withholding on RSUs can be tricky - the rate at which you are withheld varies by company. Some companies have a flat withholding on RSUs for every employee, while others allow you to adjust it. Whether this withholding amount is enough will depend on your overall income and withholding on all sources of income.
But if I’m paid in stock, how is money withheld for taxes?
The usual process involves using the newly received shares to pay for the taxes by returning some of the shares to the company in a process known as a net settlement. The company then uses its own funds to make the payroll tax deposit.
For example, if your vesting portion is 400 shares and you elected a 22% withholding, 88 shares would be withheld by AbbVie to cover the tax bill. You’ll then receive 312 shares in your E*Trade account as a net payment. AbbVie has a set withholding of 22% unless you hit a $1,000,000 threshold of vesting shares so you'll need to be actively managing your tax withholding outside of the standard company withholding.
How does my tax situation change if I immediately sell the stock versus hold onto it?
If you sell the stock the day you receive it, you likely won’t receive a tax bill as the stock price won’t have fluctuated much.
When you sell stock that you've held for less than a year, the profit is considered a short-term capital gain and is taxed as ordinary income at your marginal tax rate. This rate can be as high as 37% for individuals in the highest tax bracket. For example, you receive your shares of AbbVie in February and then sell them in January of the next year. Even though it’s a different calendar year, it’s still less than one cumulative year, so any gain would be taxed at your marginal tax rate. If the stock has gone down and you sell it before the 12-month period is up, the loss is considered a “short term capital loss” and can be used to offset any gains, or some of it can be used to offset your taxable income.
On the other hand, if you sell stock that you've held for more than a year, the profit is considered a long-term capital gain and is taxed at a lower rate, which ranges from 0% to 20% depending on your marginal tax bracket. The exact rate will depend on various factors, including your taxable income and filing status. Again, any loss can be used to offset gains, and can be carried over for future years.
How do I know if I’ve withheld enough? I don’t like surprises at tax time!
This is a problem that many corporate executives come up against. They believe that they are adequately withheld and when it comes time to file their taxes, they have a large balance being owed to the IRS.
The only way to avoid this is to run tax projections throughout the year.
This is something that I do for my clients where we run tax projections at least once a year to ensure that they are adequately withheld. If they're not, there are two things we can do - we can change withholding on any future income that's coming the rest of the year, and make estimated tax payments.
The goal is to get the balance owed at tax time as close to zero as possible.
While looking at this we're also looking at ways to defer more income such as utilizing retirement savings plans or deferred compensation plans. Tax planning for RSUs should not just be done at tax time - it's something to be worked on throughout the year.
If tax planning for RSU's is a problem you're running into, then let's talk.