The DUFF TORNEY Team

Michael Torney, CFP, J.D., LL.M. 

Restricted Stock Units (RSUs) and Restricted Stock Awards (RSAs) can be valuable parts of an executive’s overall compensation package and wealth-building strategy. Both are eventually grants of company stock provided by employers as a long-term incentive to drive performance. Understanding how they work can help maximize the value of these two types of compensation. 

Restricted Stock Units

An RSU is a legally binding right to receive company stock and is often provided to senior-level executives at established publicly held companies. While there is no immediate value on the grant date, it can be worth a significant amount of money following a vesting period. This period is the amount of time that must pass before the company will issue the shares to the executive.  

Once the RSUs vest, the executive owns the stock (or less often, the cash equivalent value of the stock). For example, an executive received a grant of 10,000 RSUs when the company’s stock price was $20 per share on January 1, 2023. All shares will vest after four years on January 1, 2027. If the company’s stock price remains at $20, the executive will receive stock valued at $200,000 before taxes on the vesting date. 

In many cases, the shares will gradually vest. For example, if the vesting period is four years, they may own 25 percent of the shares after the first year, 50 percent after the second year, and so on. 

An executive receiving RSUs will receive value even if the stock price drops. For example, if the stock price drops from $20 per share on the grant date to $15 per share on the vesting date, the executive would still receive stock valued at $150,000 before taxes.  

Once RSUs vest, they can be sold or kept like any other shares of company stock. If an executive believes the stock price will increase, they may decide to hold the stock.  

RSUs and Taxes

An executive will pay taxes when the RSUs vest and shares are distributed. The value of the shares is determined by the market price on the day of vesting and distribution. The executive will owe ordinary income tax on the value of the shares (less the purchase price paid, if any).  Since this is part of the executive’s income, the company may withhold the taxes from the employee’s wages. Some companies will withhold a set number of shares to cover the taxes. 

If the executive keeps the shares and later sells shares that have appreciated in value, they’ll owe capital gains tax on the difference between the sale price and the value of the shares upon vesting. The actual tax rate will be determined by whether there are long-term  or short-term capital gains. 

Unlike an RSA, no company stock is issued at the time of an RSU grant. As a result, an executive cannot file for a tax 83(b) election, which can be a way to reduce future taxes. 

Restricted Stock Awards

RSAs are often used by companies in the early stages of growth to attract valued employees and provide them an incentive to stay. An RSA is a grant that gives the employee the right to buy company shares – either at fair market value, at no cost, or at a discount. In its early stages, the value of a company’s stock is often relatively low, but it may increase over time, making the shares more valuable.  

Vesting

While a person receiving RSAs owns these shares, they must vest before being sold. The vesting period is often based on a number of years or is tied to the manager or executive achieving key milestones. It is common for shares to be fully vested after four years and 25 percent of the shares may be vested after each year. 

Many companies have a vesting schedule to avoid any cases where an employee leaves soon after receiving their RSAs. A company will often maintain the right to repurchase the shares until they are fully vested. 

However, if a person decides to leave a company before the full vesting period is met, they may still own some shares. For example, if they leave after two years and the vesting schedule is 25 percent each year over four years, they will own 50 percent of the shares. 

Taxes

A person granted an RSA may have to pay a certain price per share to acquire them. If the cash purchase price paid equals the stock’s fair market value, income tax will never be owed at the time of the grant. 

RSAs are bought on the grant date and any taxable gain between the grant date and vesting is normally subject to ordinary income tax. Once the shares vest, any subsequent gain between vesting and sale is subject to capital gains tax. 

83(b) Election

Future taxes on RSAs may be reduced by filing for a unique benefit called an 83(b) election. The 83(b) election is when an employee chooses to pay ordinary income tax upfront for the RSA. However, the filing must occur within 30 days from the grant date of the RSA. 

Without an 83(b) election, a person will owe income tax at each vesting event. The taxes would be calculated on the difference between the stock’s fair market value when they vest and the initial purchase price. As the company’s value grows over time, this could lead to significant taxes in the future. 

Sending an 83(b) election to the IRS means that you can choose to pay all of your ordinary income tax upfront on an RSA. One benefit is that if the fair market value of the stock equals its purchase price, there is no taxable difference. Another benefit is that the difference between the stock price at grant and at vesting will be taxed at capital gain rates (instead of ordinary income without the 83(b) election). 

Below is an example of how RSAs are taxed using regular tax calculations and an 83(b) election. 

Regular Tax Method

James is granted an RSA and accepts an award of 1,000 shares of stock. The award is for $0/share when the stock is trading at $40/share. 

Four years later, all of the stock vests and is now trading at $60/share. He decides to hold the stock for another year and then sells all of his shares when the stock price is $70/share. 

At vesting, James owes ordinary income tax on the difference between the stock price at the time of vesting ($60) and what he paid for the shares ($0), times the number of shares awarded (1,000). This means that $60,000 would be included in his wage income. When he sells the stock after meeting the long-term capital gain requirements, he will have a capital gain of ($70-$60) x 1,000 = $10,000. 

83(b) Election

James chooses to take advantage of the 83(b) election. He files this request with the Internal Revenue Service and notifies his employer. 

Even though his shares have not vested, he must pay ordinary income tax on the difference between the stock price at grant ($40 x 1,000 = $40,000) and what he paid for the shares, which is zero. The amount due will depend on his tax bracket and his total compensation. 

Four years later, when James’ shares vest, no taxes are due. He decides to hold onto the shares for another year. When he sells the stock one year later, he will have a capital gain of ($70 – $40) x 1,000 = $30,000. However, this amount will be taxed as a capital gain, which can be at significantly lower rates than ordinary income taxes for high-income executives. 

Once I receive RSUs or RSAs, what should I do?

Determine if the grant is an RSU or RSA. Next, find out the vesting schedule and determine if there are any other requirements besides vesting. You could then set a schedule so you know when your stocks start vesting.

For an RSA, decide whether to file for the special tax 83(b) election. For both an RSU and RSA, once the shares start vesting, then you need to decide if you want to keep them or sell them.

These decisions will depend on a variety of factors, including the company’s growth prospects and your own goals. If you own Restricted Stock Units or Restricted Stock Awards and would like to discuss them, contact our team at Duffteam@monetagroup.com. We are happy to discuss how we can help people maximize their wealth.

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