Restricted Stock Units (RSUs) are a common form of stock compensation offered to employees. The company issues a grant which contains a specific number of company shares. An RSU grant is a promise by your company to give you (the employee) shares of company stock in the future — after the vesting requirements have been met.

RSUs incentivize employees to stay at the company and promote practices that increase the long-term value of the stock.   

Vesting Schedule

RSU grants are usually subject to a vesting schedule. The employee does not receive granted shares until the terms of the vesting schedule are fulfilled.

Vesting schedules are typically tied to length of employment. A common schedule is 4-year vesting with 25% of the grant vesting each year on the anniversary of the grant date.

Let’s look an an example:

• you receive a grant of 100 shares on January 1st of this year
• the vesting schedule stipulates 25% vesting annually
• you would receive 25 shares on January 1st of each year following the grant date (for 4 years)

RSU equity grant documents will often include a vesting chart. This will show how your equity grant vests over time — how many shares vest on which dates.

If you decide to leave the company before the completion of the vesting schedule, any unvested shares are given up.

You can see how companies use equity grants with vesting schedules to prevent employees from leaving. Employee retention practices like these reduce turnover. Management knows that turnover is expensive. Finding your replacement involves time and money: recruiting, interviewing, negotiating compensation, training, etc.

Taxes

There are two tax categories RSU recipients should be aware of:

1) ordinary income taxes

2) capital gains taxes

Ordinary Income When Shares Vest

When the shares vest, the value of the shares on the vesting date is considered ordinary income to the employee (will show up on the employee’s W2). For tax purposes, you can think of the value received during RSU vesting as a bonus. Many public companies will set aside a certain number of shares to be liquidated for federal and state taxes.

Capital Gain after Vesting

Capital Gains Overview: Capital gains taxes are assessed on the gain produced by an investment. There are two main components for calculating the capital gain:

1) the price you bought an investment for (aka the cost basis)

2) the price you sold the investment for. Your capital gain = sales proceeds – cost basis.

If the employee decides to sell the RSUs immediately after vesting, the sale will not be subject to any capital gains taxes.

Shares Held Less than 1 Year

If the employee decides to keep the RSU shares after vesting and sells them within 1 year of the vesting date, any gains will be subject to short-term capital gains rates. The IRS will treat this short-term gain as ordinary income. Ordinary income rates are typically higher than long-term capital gains rates, meaning you’ll likely pay more taxes if you sell less than 1 year after vesting.

Shares Held Longer than 1 Year

If the employee holds the shares for longer than 1 year after the vesting date, any gains will be subject to long-term capital gains rates. Long-term capital gains rates are lower than short-term rates, resulting in less taxes paid. Although you’ll pay less taxes for holding the shares longer than one year, holding your company’s shares for an extended period involves risk. If the stock price drops substantially during the first year, it could wipe out any tax savings you were hoping to receive from long-term capital gains treatment.

Pre-Clearance

Many management-level employees are required to obtain pre-clearance before trading any shares of company stock. This is because management is often privy to material non-public information (MNPI) about the company. Buying or selling company stock while in possession of MNPI is considered insider trading. If you’re unsure whether you’re in possession of MNPI, make sure you confirm any trades beforehand with your company’s compliance department.

The tax implications of RSUs will vary based on your personal circumstances. Always consult with a qualified tax advisor or CPA if specific questions arise.