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Many high earners receive Restricted Stock Units (RSUs) as part of their compensation package. But how do they work?

Basics

RSUs are a way that companies reward employees with company stock.

Generally, you are offered a certain number of shares (or their cash equivalent) at a future date, as long as you remain employed and meet certain requirements or metrics.

With RSUs, employees don’t have to pay to acquire a company stock or exercise them in any way. Once they vest, you get the full value of the shares or cash, similar to a bonus. However, until they vest, they have no real value.

The vesting schedule outlines when and how many shares you’ll receive, so it’s important to read your company’s grant very carefully.

Many public companies offer RSUs as part of their compensation package, but private companies can also grant RSUs. Generally, private companies follow a “double trigger” event, where there is a time-based vesting schedule, along with a liquidity event or IPO.

How RSU vesting works

RSU grants typically use a time-based vesting schedule to incentivize employees to stay with the company to earn the award.

A typical vesting period for RSUs is four years. Most companies use a “cliff vesting”, where you can receive certain percentages after certain periods.

For example, it could hypothetically look like:

End of Year 1 - 5% of total RSU package

End of Year 2 - 15% of total RSU package

End of Year 3 - 40% of total RSU package

End of Year 4 - 40% of total RSU package

Some companies may issue RSUs with additional performance requirements. This is typically common for high level executives.

If you leave your company, vesting may stop and you may forfeit any unvested shares. You should always review your grant agreement, as every company has a unique plan.

How do taxes work?

Taxes are generally straightforward with RSUs. 

You do not pay any taxes when the RSUs are granted, since you don’t legally own any of the shares. 

However, once the RSUs vest, you will be responsible for paying ordinary income tax based on the Fair Market Value of the stock that day.

Some companies help their employees by withholding a portion of shares to cover the tax liability, but it’s not common so be sure to check the specific details of your plan.

For example, say hypothetically you receive 100 shares on the vesting day. The company will sell some of the shares to cover all associated taxes, like federal, state, Social Security and Medicare.  You will then receive a portion of the shares.

In many cases, if the company withholds taxes, selling immediately after vesting can results in no additional tax liability. Be sure to review your company’s plan and consult a tax professional.

If you decide to hold your vested shares  and sell later, you mayhave a capital gain or loss depending on the difference between the FMV of the shares at vesting and your ultimate sale price.

Hypothetical example

You received 100 shares at a net value of $100/share after all applicable taxes were withheld.

If you sell 100 shares at $100/share, you likely won’t owe additional taxes, as your tax liability was covered through withholding (but check your company’s plan to confirm this) and you sold at the exact FMV price your shares were granted.

If you wait 2 years, and sell for $150/share, you will have a $150 - $100 = $50/gain per share. 

If you hold RSU shares for more than a year after vesting, any gain on sale may qualify for long-term capital gains treatment.

Selling & taxes

Once you sell, you should get a 1099-B from your brokerage. 

It’s important to report it all correctly, to avoid paying any unintended additional taxes.

A sample 1099-B might look like this:

If you notice, the Cost basis is $0. This is expected as your broker doesn’t generally report a cost basis for sold RSU shares on your 1099-B.

You will need to use the “Supplemental Stock Plan Lot Detail” to figure out the correct basis and may want to consult a tax professional to make sure you get it correct.

Here, you will see the “Adjusted cost basis”. This is the correct basis you might enter into the software.

Overall

RSUs can be a valuable component of your compensation, but understanding how they vest and how they’re taxed is crucial for making informed financial decisions.

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If you want more resources on building wealth as a solopreneur/entrepreneur, check these out:

• The Solo 401k handbook

• The Roth IRA handbook

• The Self-Directed IRA handbook

• The Guide to Paying Less in Taxes

• What is a Solo 401k?

• How to Open a Solo 401k