Restricted Stock: The Beginner’s Guide (Start Here)

, Restricted Stock: The Beginner’s Guide (Start Here)
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, Restricted Stock: The Beginner’s Guide (Start Here)

Hands down, I find myself answering more questions about RSU (restricted stock units) than any other type of stock option. 

And it’s understandable: 

The way RSU work (not only with company vesting schedules but also with tax laws) is by far one of the most confusing financial concepts for startup or tech employees. 

But don’t worry…

If you’re new to understanding RSU, or only understand a little about them and know you need to know more, this is the page for you. 

I’ll walk you through all the things you don’t know yet, so you can have a much better grasp on what RSU do, how they operate, what to expect tax-wise, and how to make a solid plan for using RSU to grow your wealth. 

I’ll also include links to all kinds of articles I’ve written on RSU over the years to help you go deeper so you can understand the intricacies of this stock type.

Ready to get started?

Here we go:

1. How Restricted Stock Units Pay You

RSU are a type of equity compensation that startups and tech companies often give their employees. 

Why?

Equity compensation (including but not limited to RSU) means as a worker, your skin is in the game as well. The more you work to make the company successful, the higher your potential payout is down the line, on top of your salary. 

It’s also seen as a reward on taking a career “risk” to work for a company that’s still up & coming and isn’t totally established in the marketplace. 

While other types of equity exist, RSU are unique because you don’t have to pay for them: as soon as they vest, they’re your shares to keep… whereas with ISO (incentive stock options), you have to pay to exercise those options to turn them into shares. 

Restricted Stock Vesting 101

Restricted stock units are “restricted” because of their vesting schedule. 

When you receive RSU in your compensation package, it’s usually for a set dollar amount.

The day your RSU are granted, that amount is divided by the share price, and you receive that number of shares on the schedule outlined in your vesting schedule.  

If RSU are single-trigger, they vest based on date only. Once they vest, they’re yours to hold or sell. 

But if they’re double-trigger, that means they vest based on both time and an event… which is usually an IPO or an acquisition. 

As soon as both the date and the event happen, the stock units are then released into your possession. (This is why many people get a huge influx of vested RSU at IPO. They’ve been time-vesting RSU for years, but now that the second trigger, the event, has finally happened, all those shares release into their possession.)

To learn more, read: 

2. RSU & Taxes: Where Things Get ‘Fun’ (Read: Not Fun)

Once the IPO happens, RSU are a reliable way to obtain owned stock in your company: they’re not “options” you have to pay to exercise, they’re shares you own free and clear. 

This is pretty incredible: you’re essentially getting sellable stock in your company for free. 

However, the IRS also knows it’s a fairly easy wealth gain for you, so they make sure they get their fair share. 

Because a post-IPO RSU vest is an instant “payment” that adds hard, real numbers to your liquid net worth, they see it as cash that taxes can be easily paid out of. 

This means that when your RSU vest into stock you own, their value is taxed as ordinary income: no special, lower tax rate for investments, even if you’ve been working at your company for years before the IPO. 

Usually, in order to afford the tax bill of your RSU, you’ll have to sell some of the shares to cover it. Your company usually won’t withhold enough for you, and your salary-based withholdings by themselves aren’t likely to be enough. 

Why You’ll Owe More Tax Than Your Company Withholds

If you’ve been used to your company’s payroll department automatically withholding all the taxes you’ll need to pay: get ready for things to change after an IPO. 

Why?

A few reasons: 

1) Withholdings are done through payroll, so when your base salary amount goes up, so do your withholdings. 

~however~

2) RSU are handled through an equity awards account, not payroll. Because of this, your company will withhold taxes at a flat rate for all your equity awards, which is usually 22% for federal income taxes, and 10% for state income taxes. 

So if you’re in a tax bracket that taxes higher than 22%, you’ll have some money left over to pay. 

For example, if you’re in the 37% bracket, 37% of an additional $100,000 in vested RSU is $37,000 that you’d owe in taxes. But if your company only withholds 22% of that (or $22,000), you’ll still owe an additional $15,000 to the IRS. 

Why It Sucks if Your Share Value Goes Down 📉 👎

So far we’ve talked about the simple aspects of RSU: how they vest, how they pay you, and why you need to plan to pay more in taxes for them. 

But now we’re going to get a little bit into the complex side of RSU, and why a term called cost basis is so important. 

What is cost basis?

At its core, cost basis is the purchase price of an investment: you keep track of it to know how much you gained or lost from that investment. 

But since you don’t actually purchase RSU, their cost basis is the market price the shares were worth on the day they released. 

It’s important to know the cost basis of your RSU on the day they release, because not only is that the amount you owe taxes on, but your taxation can change based on whether or not the share price goes up or down between when the RSU vest and when you sell the shares. 

RSU Capital Losses & Wash Sales

Once upon a time, there was a company called Lyft. 

When they hit their IPO in March 2019, their stock was trading at $72 per share. (So, when their employees had RSU vest, their cost basis would be $72 per share, and that’s the rate they’d be taxed at.) 

Unfortunately, the value of the stock tanked, and just a few days later, it was trading at only $37.10 per share. The value had almost slashed in half. 

Five months later, in August 2019, the price went down even further, to only $33.42 per share.

This is significant, because normally after an IPO, there’s a six-month lock out period between the IPO and when employees are actually allowed to sell their shares that vested. 

This means that even if the employees decided to hold onto their shares in hopes that the price would go back up before they sold, they had an unrealized capital loss. They were going to be taxed on “income” that was now worth less than half of what they were taxed for. 

Fortunately, you are allowed to deduct capital losses against your capital gains, but we encourage you to read more about that here

Wash sale rules make this problem even more of a financial burden: 

Under IRS tax law, you are allowed to sell your shares at a loss, but if at any point in the 30 days before or after that sale you buy (or vest) more of that same share, your loss is disallowed. (Clearly, this rule was made to prevent stock investors from toying with the market, but it is unfortunate for tech and startup employees.) 

So, if you have a monthly RSU vesting schedule, you’re screwed. But keep your chin up, because I do have some advice later in this article that can help you make the most of your RSU, even if this is what you’re dealing with right now.

To learn more, read: 

3) Taxes After You Vest a Windfall of RSU at IPO

If you’ve been working for your company for a few years before the IPO, you’ll have a lot of RSU that vest all at once. 

And since RSU get taxed as ordinary income, it’s likely to skyrocket you into the top tax bracket and give you a higher tax bill than you’ve ever had before. So… what do you do?

Obviously, we want your tax bill to be as low as possible so you can keep more of the RSU money you’ve worked so hard for. 

So… how do you do it?

1) Lower your withholding allowances

The first line of defense to lower the tax bill you’ll owe in April is to ask your payroll department to lower those withholding allowances so you have fewer or don’t have any. More money will be held out from your paycheck for taxes, so you can help reduce the bill that way. 

2) Max out your pre-tax 401(k) savings

Depending on your tax bracket, you can get a deduction of up to $19,500 to reduce the amount you owe on your taxes. 

The value of the deduction depends on your tax bracket, but if you’re in the 24% bracket, it’ll save you $4,680. 

If you’re in the 37% bracket (which happens to a lot of people in their IPO year), that savings goes up to $7,215.

3) Delay other sources of income

You probably won’t be able to delay standard sources of income like salary, bonuses, or RSU, but there are some other things you can do. 

If it makes sense financially, you can do things like not selling other shares for short-term or long-term capital gains, because with the boost in RSU income, those will also be taxed at the highest rate. If you wait to sell until the next year, you won’t owe as much tax on those capital gains, because you’ll be back in a lower tax bracket.

4) Increase charitable giving

Just like maxing out your pre-tax 401(k), the deduction for charitable giving becomes more valuable the higher your tax bracket goes. 

On the other hand, you’ll have a higher standard deduction, which means there will be a certain amount you have to give before you start receiving a tax deduction. 

In this situation, it’s a great idea to donate your appreciated shares that you’ve held for at least one year. You get the same tax deduction as if you’d donated cash, and you avoid paying capital gains tax on the shares you donated. You get to lower your tax bill now, help a cause you care about, and avoid some taxes you’d have to pay in the future. 

5) Exercise and hold ISO (incentive stock options)

Because your double-trigger RSU increases your income, this (usually) means you can exercise more ISO without having to pay the AMT (alternative minimum tax). This won’t necessarily bring your tax bill down, but it does benefit you, because it means that you’ll have more ISO shares to sell later on, without having to deal with the headache of AMT and MTC (minimum tax credit). 

To learn more, read: 

4) When to Sell RSU (Restricted Stock Units)

Once you have the RSU in your hands and you’ve got the tax bill taken care of, the big question becomes: 

“Okay, so now what do I do with these shares?” 

When it comes to RSU, we almost always advise our clients to sell & to sell immediately

Why? 

For one, you’re already being taxed at the ordinary income rate for them, so there’s no tax advantage for holding them long-term. 

Second, you’ll probably owe more in taxes than your company withholds, so selling these shares is a great way to cover that bill without having to cut into your vacation fund.

Third, if the price goes down, you are allowed to report a realized loss… and you can use the money you get from the sale to invest elsewhere. 

You could also use the cash to exercise some incentive stock options if you believe in the long-term vision of the company, qualifying you for long-term capital gains tax rates, which are lower than ordinary income tax rates. (And you can often buy ISO at cheaper prices than the market rates, so you can have more shares for the same amount of money.) 

👉 The only time you’d want to consider holding is when the price goes up during your six-month lockout period. At that point, if the trajectory is good, you’re only half a year away from qualifying for long-term capital gains on the additional money you make on the stock. 

To learn more, read: 

Conclusion: RSU are A LOT to Understand. Work With a Professional.

This article will help you wrap your mind around the basics of RSU, but knowing all the little intricacies of RSU + tax law + long-term financial planning is something you’d only want to trust with a true, professional financial planner. 

One mistake from accidentally overlooking something could really screw up your tax bill, cost you tens of thousands more than you were expecting, and be an Achilles’ heel to your long-term financial plan that could take a long time to recover from. 

I’d hate for that to happen to you, which is why I offer free, 1:1 introductory calls to see if you’d like to work together on your tax and financial planning. 

Book a call with me here, and I’ll talk to you soon!


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