If your employer offers you restricted stock units (RSUs), then congratulations. At Levels.fyi, we understand how it is an excellent equity award with more transparent value and less risk than stock options.
However, when the income tax time comes around, restricted stock units can be a bit of a head-scratcher. With RSUs, special reporting issues often arise that can confuse even experienced financial advisors and accountants.
Read on to find out how to decipher the mysterious RSUs in Box 14 of Form W-2 and make the most out of it.
RSUs in Box 14 of Form W-2 Explained
RSUs are a common way of equity compensation offered by many tech companies like Apple, Amazon, Microsoft, and Intel. Along with other types of equity compensation, RSUs can add a substantial amount to your income every year and become a significant part of your net worth. While employee stock options get taxed when exercising options
As such, you need to understand what RSUs are, how they work, and how they are taxed.
What is a Restricted Stock Unit (RSU)?
In short, RSUs are company shares given to employees as part of their compensation. However, these shares aren't transferred to the employees right away: employees are vested in these stock options. Once they satisfy certain conditions (usually a term of employment), the RSUs are transferred to them.
RSUs that appear in Box 14 of Form W-2 indicate that shares have already been delivered to you, which happens after vesting. At this point, RSUs become taxable with implications that could affect your tax liability when filing your tax return.
Most of the time, granted RSUs are vested, meaning that they become yours after a minimum tenure with the company. While you may estimate the value of RSUs at the time they are given, the actual value will depend on the shares' fair market value at the time of vesting.
There are several possible vesting schedules:
- Graded vesting: You are vested in portions of granted RSUs over regular intervals. For example, according to Salary Stream from Levels.fyi, Microsoft offers $100,000 worth of RSUs evenly vested over five years. This translates to $20,000 worth of RSUs per year.
- Cliff vesting: All granted RSUs are delivered at once.
- Hybrid vesting : This is a mix of graded vesting and cliff vesting. For example, your employer may grant RSUs that vest over 5 years, with 20% vesting after the first year and the rest vesting in equal monthly increments for the next 5 years.
You can subscribe to Salary Stream from Levels.fyi to receive a weekly digest of verified salaries and compensation breakdown from the top tech companies, including RSUs and their vesting schedules.
RSU Vesting Schedule Example
Suppose you receive a job offer. Because the company hopes you remain a long-term employee, you are offered 1,000 RSUs in addition to salary and benefits. At the moment, the company's stock price is $10 per share, which means that RSUs are potentially worth $10,000.
To give you an incentive to stay with the company, RSUs are granted according to a five-year graded vesting schedule:
- After the first year, you receive 200 shares.
- After two years, you receive another 200 shares.
- … and so on, until you acquire all 1,000 shares at the end of five years.
Depending on how the company's stock performs over five years, you may receive RSUs valued more or less $10,000.
How RSUs are Taxed
Taxes are a critical yet often misunderstood component of effectively managing your RSUs.
RSUs aren't taxed at the time they are granted since the shares aren't technically yours yet. However, it doesn't mean you can get away without paying your fair share of taxes.
When your RSUs are vested, their fair market value is considered ordinary income and is taxed the same way as if you had received the same amount in cash. The shares' value is included in the employee's total wages for the year and is reported by the employer in Box 14 of Form W-2 at tax time.
Even if you do not sell RSUs, their value is subject to federal, payroll, state, and local taxes for that year. You will receive copies of Form W-2, providing you with the information needed to prepare your tax return.
After vesting, any change in value is taxed as capital gain or is considered capital loss once you sell your RSUs. Naturally, if the shares are sold immediately after vesting, there is no capital gain or loss. Therefore, the only taxes you owe are those on the income.
RSU Taxation Example
Let's take a look at an example of how RSU taxation works:
- You are granted 1,000 RSUs that vest in June 2020.
- The value of a single RSU is $10 at vesting time.
- The RSU income for 2020 that you owe taxes on becomes $10 x 1,000 shares = $10,000.
If you decide to sell your shares later:
- The new fair market value of shares at the time of sale is $12.
- You are to pay taxes on capital gain of ($12 - $10) x 1,000 = $2,000.
Advantages of Restricted Stock Units
Tech companies grant RSUs to their employees not without reason. The potential benefits of restricted stock units for employers include:
- RSUs provide employees with an incentive to stay with the company for longer to receive company shares at their vesting time.
- Employees are encouraged to perform well so that the shares that they own increase in value.
- Administrative costs associated with RSUs are minimal for employers, as these aren't actual shares that need to be recorded and tracked.
- With RSUs, the company can defer issuing shares until the vesting date, allowing delaying the dilution of shares.
Limitations of Restricted Stock Units
Restricted stock units are different from regular shares or share options, and they have certain limitations associated with them:
- Restricted stock units are not eligible for IRC 83(b) Election, which allows an employee to pay tax before vesting. RSUs are only recognized on the vesting date and are included in gross income for tax purposes.
- RSU owners don't have voting rights until shares are issued at the end of the vesting period.
- Unlike actual shares, RSUs don't provide dividends. However, the company may choose to pay dividend equivalents.
- If an employee leaves the company before the end of the vesting period, they forfeit the remaining shares to the company.
So how can you make the most out of your RSUs? Whether to you hold or sell RSUs depends on two factors: your overall portfolio and your financial goals.
1. RSUs as a Part of Your Overall Portfolio
You should view RSUs as a part of your larger portfolio strategy. For example, if you aim to have a fully diversified portfolio, you should sell RSUs immediately after they are vested and reinvest the proceeds in a diversified portfolio.
On the other hand, you may want to accumulate more of your company stock. However, holding a concentrated position in any one stock presents an unnecessary investment risk. As such, it is best to limit the holding of vested shares to no more than 10% of your overall net worth.
Often, employees build a concentrated position in their company's shares due to emotional attachment to the company or because they feel confident about its future. Nevertheless, it is essential to remain objective and remember that most companies underperform the market.
2. RSUs in Term of Your Financial Goals
RSUs usually vest in large portions that you have to wait for, making them similar to a forced long-term savings plan.
As soon as the shares vest, think about when you will need to use them. Holding a large value of company shares you may want to sell quickly is risky since single-stock investments are incredibly volatile. If the stock price falls next year, and you need to sell it next year, your financial goals will be in jeopardy.
So, if you plan to spend your investments in a year or two, using RSUs for the job may not be the best tool. Instead, allocate a portion of your portfolio to your company stock to serve long-term goals, like general wealth accumulation or retirement savings.
Maximize Company Stock Ownership with Levels.fyi
Owning RSUs can be a win for both you and the employer. While encouraging employees to perform better and stay with the company long-term, RSUs are a tremendous low-risk addition to your portfolio that can help you meet your long-term financial goals.
When considering possible job prospects, please pay attention to the base salary and benefits and the value of offered RSUs along with their vesting schedule. When it comes to job offer negotiation, remember that you can negotiate RSUs along with the salary!
Book a one-on-one session with an experienced recruiter from Levels.fyi to craft your salary negotiation strategy and get paid more through practical professional advice.