Restricted stock units can be a powerful part of an executive’s compensation, but if the tax side isn’t handled strategically, they can cause more problems than they’re worth.
In this video, Jeff McClean, CEO of Solidarity Wealth, sits down with Lynn Evans, Tax Advisor & Director of Family Office Services, to talk through the RSU tax issues they see most often when working with founders and executives.
Topics they cover include:
- When are RSUs taxed, and why the vesting date often surprises people
- How RSUs are different from stock options and why that matters
- What happens when companies under-withhold at vesting
- Ideas for spreading out RSU sales over multiple years
- How charitable giving strategies might work with RSU shares
Jeff and Lynn also talk about one of the biggest themes they see: too many people react to RSUs instead of planning ahead.
At Solidarity Wealth, the team works closely with successful executives and entrepreneurs to help them make more strategic decisions around equity compensation, taxes, and long-term planning. For those looking to take a closer look at their RSU strategy, this video is a great place to start.
Transcript
Hi, I’m Jeff McClean, CEO of Solidarity Wealth, and I’m here with my colleague today, Lynn Evans, who is a tax advisor and the director of our family office services. We work with executives, founders, and entrepreneurs to help them optimize and understand their wealth and wealth strategies, including managing complex equity compensation like RSUs. What are RSUs? Another way for that acronym is restricted stock units, and they can be a great tool for building and accumulating wealth, but they also have tax implications that you have to be aware of as you build and as you prepare for avoiding major tax liabilities. So today, we are going to break down some of the biggest RSU tax pitfalls we see and what you can do about them. So
RSUs vs. Stock Options: What’s the Difference?
Lynn, first question. Many executives assume RSUs are taxed like stock options or ISOs or NSOs, which are different types of stock options. Can you clarify the difference?
Certainly. First, ISOs and non-qualified stock options grant a recipient the option but not the requirement to purchase the company stock, in the future, at a specified price. While options and RSUs generally are subject to vesting requirements, when stock options vest, the option holder receives the option to purchase the stock but doesn’t receive the stock until that option is exercised. RSUs, on the other hand, when they vest, the individual actually receives the underlying stock at that time. This difference, combined with the fact that an option holder may need to use his or her own cash to exercise the option in order to receive the stock, can result in very different tax treatment, both in timing and in the amount of taxation.
Understanding RSU Tax Events
Well, that raises the key question: when do the tax events associated with RSUs occur, and how does that work?
So there are four key events, generally, with any type of equity compensation. First, you have the grant. You’ve also got vesting, exercise, and then finally the sale of the underlying stock. Each of these has different tax treatment and, depending on the type of equity compensation, can vary dramatically. With RSUs, specifically, an executive is taxed when the options vest because they receive the stock at the time. Other than that, the only other tax issue, the only other time that anything is taxed, is at the time they choose to sell that stock in the future.
Why RSU Tax Timing Matters for Executives
So why is it important then for these executives, these high-valued employees who have these plans, why is it important for them to understand the difference between taxation at vesting, which is different than taxation upon sale?
Great question, Jeff, and the biggest reason is because of the differences in tax rate. When RSUs vest, the value of the vested RSUs, the value of that underlying stock option, is included in an individual’s wages at that time. And that’s treated as ordinary income, which generally is a much higher tax rate than other types of taxes. In contrast, when they choose to sell that underlying stock, it’s taxed as capital gains, and that depends on how long they’ve held the stock. It might be taxed at higher rates or more favorable long-term capital gains treatments.
Common Pitfall: Companies Withholding Too Little Tax on RSUs
So I know one big issue with all this, with equity compensation, sometimes the company itself withholds too little at the time of vesting. Why does that catch people off guard, other than like, surprise, you have to pay more?
Jeff, that is a very big issue, and it comes up every single tax year. The reason is simple, and that’s because the companies are required to withhold at a specified rate. When RSUs vest, employers are required to withhold taxes at what is known as the federal supplemental withholding rate. This rate is typically different from what an employee would see on, for example, the rest of his wages, because the rest of his wages are based on what he’s anticipated to earn, but the supplemental rate is based solely on bonuses and, for example, RSU vesting. Now that rate, if the supplemental income is less than a million dollars in a year, that rate is only 22%. And many executives, in many cases, are already taxed at much higher rates because of their other sources of income. This means that there is going to be a difference between the total withholding amount and the total amount due on the vesting of those restricted stock units.
And sometimes what’s interesting about that situation is the company itself is completely caught off guard in their own record-keeping of once that employee crosses over the 1 million supplemental wage income, they don’t even have programs or software in place to trigger that change from 22% to the higher 34% rate.
Smart Tax Strategies for RSUs
With that in mind, Lynn, what are some smart tax strategies to minimize RSU-related taxes? Obviously, you want to end up with more money in your pocket than less, so what do you do?
The biggest way to minimize tax is to involve your trusted advisors. That’s your CPA, your tax attorney, your financial advisor. Planning in regards to when your vesting is going to happen is going to be the biggest way to help either minimize the total tax liability or also just to plan on when those liabilities are going to be due. Especially if the vesting is determined by factors other than just the passage of time, there may be ways to lump the RSU vesting together to have more vests at one time in a potentially lower tax year. If that’s an option, that’s something that should be addressed in advance.
Another option is to immediately sell some of the vested stock units to raise cash for other items such as charitable giving or tax advantage investments. Those can be other ways to lower your overall tax treatment for the year. For individuals who are charitably minded, for example, timing your charitable giving, lumping it your charitable giving together in a high tax year can also be a way of reducing your overall tax liability.
Charitable Giving with RSUs and Tax Planning
Now you raise a good point around charitable planning, charitable giving, and such as donating RSU shares. Can you kind of expand on that role of options around charitable giving and tax planning?
Charitable giving is a great way to reduce an individual’s tax liability while also helping to benefit the causes that are important to individuals. While unvested RSUs generally cannot be contributed to charity, most plans specifically prohibit those types of transfers. Once RSUs vest, however, an individual owns the shares of the company stock and it’s treated just like any other capital asset. If the value of that asset increases and you’ve held it for at least a year, an individual can contribute the stock to charity and receive a deduction equal to the fair market value of the stock. Additionally, because they don’t have to sell the stock, they don’t have to recognize the long-term gain or any gain on the sale of the stock, which compounds the impact of that gift.
You raised a good point there. Keep in mind, even though you can’t do much with the RSUs before they vest, prior to vesting, when you can actually do something once they vest, it’s a good time to include the advisor at that point. That’s a great time to talk to your CPA, talk to your advisor at a firm like Solidarity Wealth to help you understand the impact and the game plan going forward, so it’s not just you and Google trying to make a decision.
Spreading RSU Vesting Over Multiple Years
All right, Lynn, so one other question here for those with large RSU grants. Are there advantages of spreading vesting over multiple years? There definitely can be. Obviously, the biggest factor here is what does the plan allow? Because the answer in those cases is it depends. As a general rule, spreading RSU vesting over multiple years can help an executive take advantage of marginal tax brackets and take advantage of lower income tax years which could potentially reduce their overall tax liability. Individuals who are already in the highest tax bracket year-over-year consistently may not receive the same type of tax advantages but may receive other benefits to spreading the vesting over multiple years.
Again, like you said, it’s critical at this juncture to include your tax advisors and plan in advance. Yeah, and it’s nuanced too because vesting may not just be time-based, right? There may be a trigger around performance, around a liquidity event with the company. There are a lot of things that can go into vesting, and so it’s important to understand what you have and what could be coming your way.
Key Advice for Executives Managing RSUs
So, Lynn, okay, one more bonus question. I said the last one was the last question, but this is a bonus question. If you could give one piece of advice for executives managing their RSUs, what would you say?
I would actually make that two pieces of advice, and I’ve said a couple of these already, but I need to reiterate it. You hear us say all the time, don’t let the tax tail wag the dog. Taxes are an important consideration but are not the only consideration when you’re planning.
And second, planning is always more effective the earlier you start. Don’t wait until the day before or worse, the day after vesting, to start your planning because many planning options are lost at that point.
Yeah, that’s exactly right, and managing RSUs or any stock option, any equity compensation, it’s not just about avoiding mistakes. It’s making informed decisions, being educated about what you’re doing and how that fits in your overall financial plan and goals.
So here at Solidarity Wealth, my colleague Lynn and I are experts in helping clients explore strategies around tax efficiency, equity compensation, diversification, and understanding the thought process around whether to keep or sell regarding that company’s stock that you have a lot of interest in but are heavily concentrated in. And so we’d love to be a part of the conversations with you and your family. So if this applies to you, if you have equity compensation and it’s just you and Google, and some employees at lunch trying to figure it out, give us a call. We’d love to have a conversation to see how we can help to optimize your take-home from this great equity compensation that you’ve been given.
