The first question that many of my clients who work in tech ask me is: Should I sell my Restricted Stock Units (RSUs) right away?
In general, the answer is, yes, you should sell your RSUs right away as soon as they vest. This assumes that your company’s stock is publicly traded and that your employee trading window is open. Today, we’ll explain why this is typically the best answer by helping you answer the most important questions about your RSUs below.
Table of Contents
- 1 What are RSUs?
- 2 How do taxes work for RSUs?
- 3 Why might you end up owing “extra” RSU taxes?
- 4 Should you view your RSUs as a cash bonus?
- 5 What are some common misperceptions about holding your RSUs?
- 6 What are double-trigger RSUs?
- 7 Should you sell your RSUs right away as soon as you vest?
- 8 TLDR: Skip to the Video
What are RSUs?
Among the various types of employee equity compensation, Restricted Stock Units or RSUs are the kind I see most often among my Silicon Valley tech professional clients.
RSUs are employee equity in the form of company stock, which “vests” or becomes yours over time, based on your vesting schedule.
An example of a common vesting schedule would be to vest 25% of your RSU grant after one year and the remaining 75% monthly over the next three years. After you vest your RSUs, you own the stock and can keep it or sell it.
Even if you leave your company, you still own the stock.
For example, let’s say you are granted 10,000 RSUs when you start working at your company, with the vesting schedule just described. After you work one year at your company, you’ll vest 25% or 2,500 RSUs on your vesting date. Let’s also assume your shares are worth $100/share on your vesting date. You now own 2,500 shares in your company worth $250,000. Once they vest, you can keep your RSU shares or sell them, before or after you leave your company.
How do taxes work for RSUs?
The next critical, and often misunderstood question for you to answer, is how taxes work for RSUs. When you vest your RSUs, you are immediately taxed on their fair market value, which is treated for tax purposes as ordinary income. That means that your RSUs are taxed at the same rate as your salary.
This is different from other types of employee equity such as Incentive Stock Options (ISOs), which are not taxed immediately when you vest them. This difference often causes confusion. Let’s illustrate how RSU taxes work.
We’ll continue with the previous example and assume you vest 2,500 RSUs worth $100/share, or $250,000 total. On your vesting date, the $250,000 worth of RSUs become immediately taxable as ordinary income at ordinary income rates—whether or not you also sell any of the vested shares.
Procedurally, your company typically estimates your tax withholding, sells some of your vested RSUs to pay those taxes, and leaves you with the remaining unsold RSUs to do with as you please. Let’s assume your company estimates you need to withhold $80,000 in taxes. The company will sell 800 of your RSUs at $100/share to pay the $80,000 and leave you with the remaining 1,700 RSUs worth $170,000 in your employee equity account.
Again, the key takeaway is that you get taxed on your RSUs as soon as you vest your RSUs and your RSUs get the same tax treatment as your salary.
Why might you end up owing “extra” RSU taxes?
There’s another common trap to watch for when you vest your RSUs, or you end up with a shocking surprise tax bill on Tax Day.
As we described in the example above, your company estimates your tax withholding and sells some of your vested RSUs to cover that amount. Let’s assume the company withholds 22% for Federal tax withholding which is typically the case for most employees. However, let’s also assume that you are actually in the highest Federal income tax bracket of 37% this tax year. This means that you may owe an additional 15% of taxes on your vested RSUs which you have not paid yet because the company withheld at 22% and you should have been withheld at 37%.
The company under withheld 15% in Federal taxes that you still owe.
You can avoid this unpleasant surprise by working with a tax professional or financial planner to make sure you pay estimated taxes in the quarter you vested, or at least set aside reserves to cover this tax bill when you file your annual returns.
Should you view your RSUs as a cash bonus?
One way my clients often find it helpful to think about RSUs is to view them as a cash bonus in the form of company stock.
Let’s imagine two versions of receiving company stock.
a. The RSU Version: Let’s assume you vest $250,000 of RSUs. The company estimates you need to withhold $80,000 for taxes, so it sells $80,000 of your RSUs and leaves you with $170,000 of company stock.
b. The Cash Bonus Version: Let’s assume you get a cash bonus of $250,000. The company estimates you need to withhold $80,000 for taxes which leaves you with $170,000 in cash. You take your $170,000 of cash and you buy $170,000 of your company stock in the stock market (assumes your company is publicly traded). This leaves you with $170,000 of company stock.
Both the RSU and Cash Bonus versions leave you with the exact same $170,000 worth of company stock. Which brings us to our next question…
If you received a cash bonus, would you first use it to buy company stock?
Now that you understand you can view your RSUs as being the same as a cash bonus, you can ask yourself: If your company gave you a cash bonus today, would you first use it to buy company stock?
When I ask clients this question, most of them say that buying company stock would not be the first way they would choose to use a cash bonus. If that’s the case, you should not hold onto your RSUs. Doing so is the same as saying that buying company stock would be the first way you would use a cash bonus.
This is one reason I typically recommend my clients sell their RSUs as soon as they vest and use the proceeds to fund other financial goals. This can include achieving near-term goals such as funding an emergency fund or making a down payment or your long-term goals such as investing for retirement in a broadly diversified, globally allocated portfolio. You might want to spend a small amount of it as well, for a job well done!
What are some common misperceptions about holding your RSUs?
There may be a few exceptions to the general rule about selling your RSUs once they’re vested. However, they are not the most common reasons I hear when a client is thinking about holding onto their vested RSUs. Usually, it’s either because they want to keep a stake in their company, and/or they mistakenly believe there are tax benefits to doing so.
Let’s consider each of these justifications in turn.
Keeping a stake in your company: This is the most common reason I hear for holding onto vested RSUs. But remember, you are already invested in your company in the form of your salary, benefits, and future equity potential. If you still want to keep a stake, I’d suggest limiting it to less than 20% of your investable assets, so you’re not taking on too much concentrated risk by holding too much of a single company’s stock.
Holding your RSUs for tax benefit: We hear this one a lot too. But because Restricted Stock Units are taxed as ordinary income, there is typically no tax benefit to holding them. Some clients will argue, if they hold RSUs for more than a year, they will qualify for a lower long-term capital gains rate. However, the long-term capital gains rate only applies to the gain on the stock price after the vesting date. If you bought stock on your vesting date and held it for more than a year, that stock would also qualify for the long-term capital gains rate. You get the exact same tax treatment if you hold your RSUs or buy the stock, so there is no tax benefit from holding RSUs.
An Illustration: No tax benefit for holding your RSUs
Let’s revisit the previous example to illustrate that there is no tax benefit for holding your RSUs.
We’ll continue with the previous example, and assume you held your $170,000 of RSUs for more than a year and then sold them for $180,000. Your $10,000 gain would qualify for long-term capital gains treatment.
Alternatively, imagine you took your after-tax cash bonus of $170,000 and bought $170,000 worth of company stock, held it more than a year, and sold it for $180,000. Your $10,000 gain would also qualify for long-term capital gains treatment, just as it did from holding the vested RSUs. You’re in exactly the same place for the tax treatment of your gain. And by the way, whether you held or sold those vested RSUs, you’d also pay ordinary income tax on their fair market value at vesting.
What are double-trigger RSUs?
Most RSUs work as described above. But before we wrap up, I want to cover another less common version of RSUs you may come across. If your RSUs were issued by a private company, they may be what are often called double-trigger RSUs. These RSUs require two triggers, or events, to occur before you own your RSUs:
- You must work at the company long enough to vest your RSUs based on your vesting schedule; AND
- Your company needs to complete a liquidity event such as going through an IPO or being acquired.
After both triggers occur, you own the RSUs, and you owe taxes on their vesting. You’ll want to be aware if you have double-trigger RSUs, because their tax treatment differs from the “regular” RSUs held by tech professionals at publicly traded firms.
For example, let’s assume you were granted 10,000 double-trigger RSUs by your private company. They have a four-year vesting schedule with 25% vesting after one year and 75% vesting monthly over the next three years.
After one year of working at the company, you vest 25% or 2,500 of your double-trigger RSUs based on your vesting schedule. However, if the second trigger of a liquidity event hasn’t occurred, you don’t yet actually own the RSUs or owe taxes on the vested shares.
Now, let’s assume your company has its IPO after you’ve worked there for two years. Once the second trigger has occurred, AND you’ve vested 50% or 5,000 of your double-trigger RSUs, you would own 5,000 double-trigger RSUs, with taxes due on the fair market value and treated as ordinary income.
If you hold double-trigger RSUs, additional planning is warranted as you consider how to best manage them.
Should you sell your RSUs right away as soon as you vest?
Given that RSUs are taxed as ordinary income and there is no tax benefit for holding them, I typically recommend you sell as soon as you vest and use the proceeds to fund your other financial goals.
Another way to figure out when to sell your RSUs is to ask yourself: If I my company gave me a cash bonus today, would I first use it to buy company stock? If you wouldn’t use your bonus to buy company stock, you should consider selling your RSUs.
TLDR: Skip to the Video
Deciding when to sell your RSUs can be hard to figure out. After all, as a tech professional, you probably want to spend most of your time and energy innovating in your industry, not fussing over your tax returns.
That said, you also want to make the most of your equity compensation. Using the framework I’ve outlined in this post, you can decide on your own how to make the most of your hard-earned RSUs if you like this type of work, or if you want to work with a specialized financial planner with the experience to guide you through your specific situation, please schedule a free virtual consultation.