Have RSUs? Learn How to Navigate Their Tax Challenges
In today’s competitive workforce, many employers look for innovative ways to compensate employees and retain top talent. Restricted stock units (RSUs) are one way to accomplish this goal, as they provide employees with a stake in the company’s success while reducing the amount of cash a company must dole out. While RSUs can be a valuable form of incentive compensation, they also present unique tax challenges. Following are tips to help you navigate your RSUs.
What Are RSUs?
RSUs are a type of incentive compensation granted to employees (typically executives) as part of their overall compensation package. RSUs represent a commitment by the employer to grant a certain number of shares to the employee once that employee has completed a designated vesting period.
Unlike traditional stock options, which provide employees with an opportunity to purchase shares of company stock at a predetermined price, RSUs are issued as shares of company stock. Once the employee has completed the applicable vesting period, he or she gains ownership of the RSUs.
Benefits of RSUs
RSUs offer several benefits for both employers and employees. Employers often use them to attract and retain top talent, as well as to align employees’ interests with those of the company. RSUs can help encourage employees’ commitment and dedication to achieving corporate objectives.
Employees with RSUs have an opportunity to share in the company’s growth and success. As the stock’s value increases over time, so does the value of the RSUs, which can potentially result in a significant windfall for employees who own them. In addition, RSUs are typically less risky than traditional stock options, because employees don’t invest their own money to purchase shares.
Tax Challenges of RSUs
While RSUs offer distinct advantages, they also present several tax challenges, including the following.
- Vesting taxation – One of the most significant drawbacks of RSUs is the tax liability they place on your personal finances upon vesting. In the year your RSUs vest, they’re considered taxable income even if you don’t sell the shares. The current market value of your RSUs is taxable as current income during the year in which the shares become available to you. You may also be subject to additional taxes, such as those for Social Security and Medicare. This situation can result in a significant tax liability if not properly managed.
- Withholding and selling RSUs – To cover your potential tax liability in the year your shares become vested, your company may withhold a portion of the vested shares (called a cashless exercise). Or you may choose to sell some of your vested RSUs to cover your taxes. However, the decision to hold or sell RSUs can impact your capital gains taxes based on the shares’ holding period.
- Capital gains tax – If you choose to hold the vested RSUs after they’re transferred to you, any subsequent appreciation in the stock’s value will be subject to capital gains tax once you sell the shares. The applicable tax rate (short-term or long-term capital gains) depends on how long you’ve held the shares.
- Multijurisdictional tax complexities – If you work for a multinational company or have a cross-border employment arrangement, you may face additional tax complexities related to your RSUs. Different countries have varying tax rules regarding RSUs, and it can be challenging to coordinate your tax obligations across multiple jurisdictions.
Tips for Managing RSU Tax Liabilities
The following strategies can help lower your RSU tax liabilities.
1. Proactive tax planning
Working alongside your Creative Planning wealth manager, our in-house tax professionals can help you anticipate and plan for the tax implications of your RSUs. Your team can help you understand your potential tax liabilities and implement strategies to reduce the amount you owe, such as:
- Deferred vesting – Your company may offer the option to defer the vesting of your RSUs to a future date. If so, your wealth manager and tax advisor may advise you to do so in order to better control the timing of your tax event, potentially deferring taxation until a year in which your overall tax liabilities are lower.
- Vesting spacing – If you have multiple RSUs scheduled to vest at different times, your wealth manager and tax advisor may be able to strategically manage the timing of these taxable events to help minimize your tax liabilities.
2. Tax-advantaged accounts and index funds
If you decide to sell your shares and invest the proceeds, it may be wise to consider tax-advantaged accounts and/or index funds. You can consider using some of the proceeds from the sale to fund additional 401k contributions to your employer plan or contribute to your IRA for the year, both of which can potentially lower your current year’s tax liability while allowing your assets to grow tax-deferred for retirement. You can also consider investing the proceeds into a taxable account using low-cost index funds, which can offer diversification and tax efficiencies (as they typically generate fewer taxable events than actively managed mutual funds).
3. Sell to cover
When your RSUs vest, you may wish to sell a portion of the shares to cover your associated tax liabilities. While this can be a good way to avoid using your own savings to cover the taxes, it’s important to carefully plan for the sale.
- Be strategic –Your wealth manager and tax advisor can help ensure you sell only the required number of shares to cover your taxes. This practice allows you to continue maximizing your stake in the company’s success while still managing your current year’s tax impact.
- Consider capital gains –If you choose to hold RSU shares before selling, it’s important to be aware of the holding period. Holding shares until they qualify for long-term capital gains treatment can significantly lower your tax liabilities.
4. Charitable donations
Making a donation to a charitable organization can provide a tax deduction as well as a way to give back to your community. If your eligible tax deductions for the year exceed the standard deduction, this can reduce your tax liability. There are a few ways you can give to charitable organizations to receive a tax deduction:
- Donate cash – Contribute proceeds from the sale of your RSU shares to a charitable organization.
- Donate appreciated stock – If you have a taxable brokerage account that holds appreciated stock with a long-term gain, consider donating the stock directly to a charity. You receive the tax deduction for the fair market value of the stock and the charity can sell it and won’t pay capital gains taxes. You can then use some of the cash from the sale of your RSU shares to repurchase the appreciated stock you donated to the charity (which resets your cost basis).
- Establish a donor-advised fund –Contributing proceeds from the sale of your RSU shares to a donor-advised fund allows you to claim a charitable deduction in the year of the contribution while distributing donations to various charities over time. This can be a great tool to use when you want to make a large donation and aren’t sure of the ultimate charitable organizations you want to benefit.
RSUs can be a valuable form of incentive compensation, but the tax complexities they add to your financial life should be carefully managed. At Creative Planning, we’re here to help you navigate those complexities and maximize the benefit of your RSUs. Our wealth managers and in-house tax professionals work together to ensure your entire financial life is working together in pursuit of your goals. To learn more, schedule a call with a member of our team.