As an employee, you might receive various forms of compensation. These likely include wages or salaries, various forms of insurance, bonuses, paid time off, and pension plans.
You might also receive restricted stock units, or RSUs. RSUs typically come to you through a vesting plan or distribution schedule. These might be in the form of performance milestones or the number of years you remain with your employer.
But once those RSUs are vested, do you pay capital gains taxes on the proceeds? The answer is somewhat complicated.
The Function of RSUs
RSUs are used as a compensation tool by companies to attract and retain the best and brightest employees. RSUs are especially helpful when it comes to employee retention. The longer you remain (and the higher the price of the company’s stock), the more likely you’ll benefit when vested.
The takeaway here is that RSUs aren’t actually stock shares. You don’t receive dividends from them, nor do they give you voting rights as a shareholder. Rather, RSUs promise you that after you reach a certain milestone, you’ll receive shares of the company’s stock.
Vested, Taxed Twice
Once RSU shares vest, your company converts them into actual stock shares. They become your property. They also represent taxable compensation. In other words, the market value of that vested stock is now taxable at your ordinary income rate. Your company withholds income tax and payroll taxes on the amount, typically by selling enough of the shares to pay the tax.
That’s the first tax. The second tax – capital gains tax – kicks in if you decide to sell the stock. The capital gains (or losses) represents the difference between the sales price and the cost basis. The cost basis represents the shares’ market value on the day you receive them from the company.
But we’re not finished yet. Based on IRS rules, your capital gains are classified as short-term or long-term. These classifications carry different taxation rules:
- If you sell your shares within a year of receiving them, this is considered a short-term hold. The proceeds from the sale are taxed at the ordinary income rate.
- If you sell your shares after holding them for one year or longer, this is considered a long-term hold. The proceeds from the sales are taxed at the capital gains rate.
The issue to consider is that ordinary income can generally be taxed at a higher rate than capital gains. Additionally, stock compensation could push your taxable income into a higher bracket – leading to higher taxes.
Prepare Before Vesting
Though RSUs are a compensation benefit to reward you for achieving various milestones, they also should be part of a carefully thought-out strategy. You will be taxed on RSUs, both when they’re vested and when you sell the shares of stock. But working with a financial advisor and/or tax professional can help you better schedule the disposition of your stock. This, in turn, could help reduce some of your tax burden.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
