Restricted Stock Units and How They Affect Your Clients’ Taxes

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As traditional stock options have become less popular in the last 20 or so years, many companies replaced them with Restricted Stock Units (RSUs). Because these units vest over time, companies use RSUs to attract employees by offering incentive compensation as well as to retain talent.

RSUs are a way a company can grant shares of stock to employees as compensation. They are restricted because they can’t be sold until they vest. RSUs are governed by other limits a company can impose, and the vesting schedule can be based on length of employment or on performance goals. For example, if you vest over four years, you will typically receive 25 percent of the grant each year for four years. Vesting schedules can vary, including annually, quarterly, monthly or in some combination.

Unlike stock options, RSUs don’t have a purchase or exercise price. RSUs also differ in that when vesting occurs, the stock is issued directly to your clients; they aren’t exercising or purchasing the shares.

When RSUs vest, they convert into shares of company stock. The government requires the issuing company to withhold a specific amount of tax when RSUs vest. So, when your clients’ RSUs vest, the company calculates the value of the stock, or the number of shares vesting multiplied by the closing stock price on the vesting date. The company then determines the amount of taxes due, then withholds enough shares to cover the amount of taxes due. Finally, a company will deliver the remaining shares (net shares) to your client within a few days after the vest date. It’s important to note that the client will experience taxable income on the full value of the stock when it’s granted, but will only receive a portion of that amount in stock after withholding is considered.

How Does an RSU Work?

  • Compensation is offered in the form of company stock.
  • Stock is not received with the granting of the RSU, but instead when the stock vests, either after achieving required performance milestones, or upon remaining with the employer for a particular length of time.
  • When they vest, they are considered income, a portion of the shares are withheld to pay income taxes, and the employee receives the remaining shares and can sell them at any time. The taxpayer/client has basis in the shares equal to the ordinary income that they recognized on the shares that were issued to them, based on the value on the vesting date.

An RSU Example

A company grants your client 2,000 RSUs when the market price of its stock is $22. The 2,000 RSUs will vest at a rate of 25 percent a year.

Year one

Five hundred shares will vest at $27 (500 x $27 = $13,500) The $13,500 is considered “ordinary income” and taxed as such. The W-2 will include the RSU amounts as taxable wages as well as the related federal and state income tax withholdings.

Taxation

  • Federal Income tax withheld at 25% = $3,375
  • Social Security tax at 6.2% = $837
  • Medicare tax at 1.45% = $196
  • State and local tax at 9% = $1,215
  • Total taxes = $5,623

Option one – Shares of stock after income tax

  • $5,643 at $27 per share to cover income taxes
  • All sales must be in whole shares, so there may be some remaining cash from the fraction of the shares that was not needed for taxes. Any cash remaining after tax withholding is satisfied will be refunded through local payroll.
  • $7,857 per $27 share = 291 shares of stock.
  • 291 shares of stock go into your client’s account, and 1,500 RSUs remain.

Option two – Same-day sale of stock (your client sells the stock the same day, making it a short-term event)

  • Sale of 291 shares at $27 per share = $7,857.
  • Cost basis (291 shares at $27) plus transaction fee of $5 = $7,862.
  • Gross sale $7,857 less cost basis $7,862 = (-$5).
  • As a preparer, you need to verify cost basis and transaction fees from the reporting 1099. Report the transaction on Form 8949, Sales and Dispositions of Capital Assets, and Schedule D. It’s important to note that these are often uncovered transactions, so the cost basis may not be provided on the 1099-B.

Year two

Five hundred shares will vest at $18 (500 x $18 = $9,000). The $9,000 is considered “ordinary income” and is taxed as such.

Taxation

  • Federal Income tax withheld at 25% = $2,250
  • Social Security tax at 6.2% = $558
  • Medicare tax at 1.45% = $131
  • State and local tax at 9% = $810
  • Total taxes = $3,749

Option one – Shares of stock after income tax

  • $3,762 at $18 per share to cover income taxes.
  • $5,238 at $18 a share = 291 shares of stock.
  • 291 shares of stock go into your client’s account, and 1,000 RSUs remain.

Option two – Sale of stock two years after vesting (your client sells the stock two years later, making it a long-term event)

  • Sale of 291 shares at $35 per share = $10,185.
  • Cost basis (291 shares at $18) plus transaction fee $5 = $5,233.
  • Gross sale $10,185 less cost basis $5,233 = $4,952.
  • The result is a long-term capital gain and is taxed at those rates. As the preparer, you need to verify cost basis and transaction fees from the reporting 1099. Report the transaction on Form 8949 and Schedule D.

restricted stock units

RSUs are a common way to attract and retain employees in today’s competitive marketplace. Ensure your clients understand how they work and the tax ramifications connected to them.

Editor’s note: Be sure to read Michael Tullio’s article about employee stock purchase plans on the Intuit® ProConnect™ Tax Pro Center.

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