Overview of Restricted Stock Units (RSUs)
Restricted Stock Units (RSUs) represent a form of equity-based compensation commonly offered by companies, particularly in technology, startups, and larger corporations. RSUs are awarded to employees as a promise to deliver company shares in the future, contingent upon fulfilling specified requirements — usually continued employment over a designated vesting schedule. Unlike stock options, RSUs don’t require employees to purchase shares. Rather, shares are granted outright once vested.
How RSUs Vest and What It Means
Vesting is the process by which employees earn the right to own their RSUs. Typical vesting schedules range from three to five years. For example, a four-year vesting plan might release 25% of the awarded RSUs each year. There can also be “cliff” vesting, where all RSUs vest at once after a set period (often one year).
During the vesting period, if an employee leaves the company, any unvested RSUs are usually forfeited and returned to the company. Only after vesting do employees gain the ability to sell, transfer, or otherwise exercise ownership over the shares.
For more details on vesting schedules, see our article on vesting schedule.
Reasons Companies Use RSUs
Companies use RSUs as a talent retention and motivation tool. RSUs align employees’ interests with those of shareholders by providing a stake in the company’s success. They offer an advantage over cash bonuses by incentivizing long-term commitment and performance. For startups, RSUs offer a way to compensate employees when cash flow may be limited.
Taxation of RSUs in the United States
In the U.S., RSUs have specific tax implications governed by the IRS:
- At Vesting: RSUs are taxed as ordinary income based on the fair market value of the shares at the vesting date. That amount is included in your W-2 income and subject to income tax and payroll taxes (FICA for Social Security and Medicare).
- At Sale of Shares: When you subsequently sell the vested shares, any gain or loss compared to the market value at vesting is treated as a capital gain or loss. Holding the shares for over a year after vesting qualifies gains for the lower long-term capital gains rate.
The IRS provides official guidance on RSU taxation in IRS Publication 525 and related resources.
Example Illustration
If you receive 1,000 RSUs priced at $50 per share:
- After the first year, 250 shares vest, valued at $12,500 — you must pay income tax on this $12,500.
- If you hold those 250 shares and later sell them for $60 each, the $10 per share increase is a capital gain.
- If stock price falls below $50, your capital loss could offset other gains.
Common Strategies and Considerations
- Tax Planning: Since RSU income can push you into a higher tax bracket, set aside funds for the tax impact at vesting.
- Holding vs Selling: Deciding when to sell vested shares depends on your risk tolerance and financial goals.
- Know Your Company’s Rules: Some firms have trading windows or blackout periods restricting share sales.
- Consult Professionals: Tax and financial advisors can help navigate complex RSU scenarios, especially if you relocate or receive international RSUs.
Clarifying Common Misunderstandings
- RSUs are not stock options. They do not give you the right to buy shares but rather a promise to receive shares outright once vested.
- The value of RSUs isn’t realized until they vest; unvested RSUs hold no financial value and are typically forfeited if you leave early.
- Taxes on RSUs occur at vesting, which can come as a surprise if you’re unprepared.
Additional FAQs
Can I sell my RSU shares immediately after vesting? Usually yes, but companies often impose trading restrictions or blackout periods. Always check your company’s equity plan.
What happens to RSUs if the company is acquired? RSUs might accelerate vesting or convert into shares of the acquiring company based on deal terms.
Are RSUs subject to payroll taxes? Yes, since the IRS treats vested RSUs as ordinary income, they are subject to Social Security and Medicare taxes.
Summary Table: Key Features of Restricted Stock Units (RSUs)
| Feature | Description |
|---|---|
| Type of Compensation | Equity-based, shares granted upon vesting |
| Vesting Period | Typically 3-5 years, based on employment |
| Taxation | Taxed as ordinary income at vesting, capital gains upon sale |
| Purchase Required | No, shares are granted, not purchased |
| Ownership | Begins after shares vest |
| Common Employers | Tech companies, startups, large corporations |
For a comprehensive understanding of how vesting affects your RSUs, visit our vesting schedule page.
Sources:
- IRS Publication 525, Taxable and Nontaxable Income (irs.gov)
- Investopedia, “Restricted Stock Units (RSUs)” (https://www.investopedia.com/terms/r/rsu.asp)
- NerdWallet, “How Restricted Stock Units (RSUs) Work” (https://www.nerdwallet.com/article/investing/restricted-stock-units-rsuites)
For more information on managing your equity compensation, see our guides on capital gains and income streams.
