Restricted Stock Units (RSUs) – How They Work & 6 Common Misconceptions

RSUs are a form of compensation issued by employers to employees in the form of company equity, or shares. RSUs tend to be most common among mature public companies, particularly in tech and healthcare, given the relative convenience and popularity of them with employees. In addition, while startups and earlier-stage private companies tend to use incentive stock options (ISOs) and restricted stock, public companies often find these to be too expensive to offer to rank-and-file employees. RSUs are a major part of employee pay at Amazon (AMZN), Facebook, Pfizer, Tesla, and other major companies.

This blog will briefly discuss how RSUs work, how they are taxed, and cover six common misconceptions to avoid if they are part of your compensation package.

What are RSUs and how do they work?

RSUs are shares delivered via delayed stock grants, often received at initial hire, subsequent promotions, and/or as part of performance reviews. RSUs come with a vesting schedule based upon a particular length of time, performance milestones, or both. Most RSUs only have a time-based vesting schedule, while performance-based schedules are more common for top company executives (referred to as PSUs – performance stock units).

Vesting schedules can vary from company to company, but a common structure is a 4-year grant with a 1-year cliff vest requirement, followed by monthly vesting of shares thereafter. By way of example, consider an AMZN employee, Sarah, who recently joined the company and received an RSU grant with this structure:

  • Example #1: Sarah receives a grant of 100 shares of AMZN stock on 4/1/2024; this is her grant date. With a 1-year cliff and subsequent monthly vesting schedule, no shares will vest until one year later. On 4/1/2025, 25 shares will vest to Sarah, and her remaining 75 shares will vest monthly for the remaining three years. See the table below (shares are rounded down to the nearest whole number):
DateEventAmount
4/1/2024Grant Date100
4/1/2025Vesting Date – 1 yr. cliff25
5/1/2025Vesting Date – first month2
4/1/2028Vesting Date – final month2

How are RSUs taxed?

RSUs are part of your employer’s compensation package and are taxed as ordinary income based on the stock’s fair market value (FMV) on the vesting date. The vesting date (for public company RSUs) is the only trigger for income tax liability. At the vesting date, income from RSUs is subject to federal, state/local, and FICA tax withholding. RSUs are considered “supplemental income,” meaning they are subject to mandatory federal withholding rates of 22% for income less than $1 million or 37% for income greater than $1 million. See below for a simple example:

  • Example #2: Recall Sarah who received a grant of 100 shares of AMZN stock on 4/1/2024. One year later, on 4/1/2025, 25 shares vest after the 1-year cliff. Assume AMZN’s FMV on 4/1/2025 is $400:
    • Income: 25 shares x $400/share: $10,000
      • Federal withholding – 22%: ($2,200)
      • FICA – Soc Security – 6.2%: ($620)
      • FICA – Medicare – 1.45%: ($145)
      • Total Tax Withholding: ($2,965)
    • Shares withheld: $2,965/$400 = 8 shares
    • Shares received:  25 – 8 shares = 17 shares
  • Because Sarah’s RSU income is $10,000 (far short of $1 million), she is subject to the 22% federal withholding rate.
    • If Sarah lived in a state like New York or California, additional mandatory withholding would apply for state income taxes. New York has an 11.70% rate for supplemental income.
  • Assuming Sarah has not yet reached the Social Security wage cap for the year, an additional 6.2% of withholding applies. The 1.45% Medicare withholding has no income cap.
  • Finally, as shown in the example, shares are withheld at vesting based on dividing the tax owed by their FMV; the remaining net shares are deposited to Sarah’s brokerage account.

Two important notes – first, the 22% federal income tax withholding rate might not be sufficient to cover the full tax that Sarah owes (keep reading for more on this point). Second, this post does not consider the tax implications of RSUs granted by a private company. In short, private company RSUs lack liquidity and commonly have an additional “trigger” for an income tax liability to occur (often referred to as double-trigger RSUs, they are beyond the scope of this post).

What are common misconceptions about RSUs?

#1: A company offer letter specifying a dollar amount of RSUs (e.g., $100,000) means you are guaranteed to receive that money.

Employer offer letters will often quote a total dollar amount of RSUs based upon the share price on the grant date. The formula used is simple:

  • Example #3: Recall Sarah who received a grant of 100 shares of AMZN stock on 4/1/2024. Assume the stock price at grant was $300 per share.
    • Shares granted = Target dollar amount / Share price on grant date
    • 100 shares = $30,000 / $300

Sarah’s offer letter likely noted $30,000 of RSUs (100 shares) as part of her total compensation, but this can be misleading. The market price on the vesting date determines Sarah’s compensation and will change over time; the offer letter uses the price on the grant date. She could receive more or less than $30,000 depending on how AMZN does over time. Of course, most employees and RSU holders hope the price goes up! But this is not always so.

To further illustrate the point, consider examples where Sarah receives a $100,000 RSU grant from AMZN, or instead she receives a $100,000 RSU grant from Peloton (PTON). In both examples, assume the grant date is 3/1/2020, with a 4-year vesting where shares vest 25%/year:

CompanyAmazon
Share Price on Grant Date$97.70
Grant Dollar Amount$100,000
Grant Date3/1/2020
Shares Granted1024
Vesting ScheduleShares VestingShare PriceIncome
3/1/2021256$157.31$40,271.36
3/1/2022256$151.14$38,691.84
3/1/2023256$92.17$23,595.52
3/1/2024256$178.22$45,624.32
Total1,024$148,183.04

Sarah’s $100,000 grant results in her being awarded 1024 shares. $100,000 divided by the grant price of $97.70 on 3/1/2020 equals 1,024 shares. As the table shows, other than a slight decline in 2023, AMZN’s share price continued to rise over time as the vesting dates occurred. As a result, Sarah’s grant ended up delivering close to $150,000 of value. Let us consider a different example.

CompanyPeloton
Share Price on Grant Date$27.92
Grant Dollar Amount$100,000
Grant Date3/1/2020
Shares Granted3582
Vesting ScheduleShares VestingShare PriceIncome
3/1/2021896$123.81$110,933.76
3/1/2022895$27.62$24,719.90
3/1/2023896$12.66$11,343.36
3/1/2024895$4.60$4,117.00
Total3,582$151,114.02

Here, Sarah’s $100,000 grant sees her being awarded 3,582 shares of PTON, based upon the grant price at grant of $27.92. While the total value of the grant was also ~$150,000 (and slightly more than the AMZN example), the stock price trajectory of PTON is completely different. It took off in 2020 but fell precipitously each year since. If Sarah held onto all her vested shares, they would be worth far less than $150,000 today.

#2 – There is a tax advantage to holding RSUs at least one year after they vest.

A common mistaken belief is that if you hold vested RSU shares for at least one year, the shares will be taxed at preferential (lower) long-term capital gains rates. This is not true. Remember, RSUs are taxed as ordinary income based on the number of shares vesting x the market price on the vesting date. So, you were already taxed on the RSUs when they vested. If you continue to hold the net shares received, only the gain (if one exists)since the vesting date will be eligible for capital gains tax treatment.

The decision to hold vested RSU shares depends on several important considerations – your risk tolerance, age, other financial goals, existing concentration of the stock, how well you expect the company to perform, and so on. Holding vested shares can make sense but should generally be done sparingly.

#3 – RSUs are different from a cash bonus.

Whileyou receive shares when RSU vests occur, the tax treatment is no different than if you instead received cash. A $100,000 cash bonus is taxed the same as $100,000 of vested RSUs. The question then becomes whether to hold the vested shares or sell them immediately.

To simplify, consider the following: if I had instead received a cash bonus, would I turn around and buy an equivalent amount of company stock? If the answer is no, you should sell the shares. If the answer is yes, the considerations raised in #3 above resurface. From a planning perspective, many people benefit from immediately selling their RSUs in full at vest. Why? Because selling helps you diversify your holdings and helps free up cash for other savings or spending goals. You might be reticent to do this and think the stock price will keep going up. Perhaps it will, but if it does not, will you regret not selling sooner? Will you still be able to accomplish your goals?

#4 – The tax withholding from my paycheck will be sufficient to pay the tax owed from RSU vests.

RSUs are considered supplemental income and withheld at mandated federal withholding rates when they vest. These withholding rates are:

  • 22% = if supplemental pay < $1M
    • 37% = if supplemental pay > $1M

If you are a high earner, have RSUs vest, and your effective tax rate is > 22%, you could owe additional tax and/or face underpayment penalties the following year. This can happen if your taxable income exceeds ~$250,000 for a single individual or ~$500,000 if married filing jointly based on 2024 tax tables. You should also know that many companies will not let you adjust your RSU withholding at vesting (some will, but it is operationally cumbersome and not the norm).

What should you do if you find yourself in this situation? Work with your advisor and tax professional to either adjust your paycheck withholding higher OR make quarterly tax estimates. If making quarterly estimates, any payment helps, but you will want to be sure to pay them on the appropriate due dates.

#5 – You can make Section 83(b) election with RSUs to reduce future taxes owed.

An 83(b) election notifies the IRS you wish to be taxed on your stock award at the time it is granted, rather than when it is vested and fully received. For early employees and start-up founders, making an early 83(b) election can be important to reduce future income tax (and potentially beneficial for QSBS purposes). However, it is only an option for certain types of equity awards, like restricted stock, early exercises of employee stock options, and profits interests; you cannot make an 83(b) election for RSUs.

RSUs are taxed as compensation income at the vesting date. Before that point, you do not own or have the right to any shares; you cannot make an 83(b) election for an equity award you have not yet received.

#6 – The Form 1099-B from the custodian holding my shares from vested RSUs is all my tax preparer needs to file my return.

This is the inverse problem of #4. Form 1099-B reports capital gains and losses from selling securities (e.g., vested shares) and is issued by the custodian holding your vested shares. It will have the incorrect cost basis, typically $0. Why? Because IRS rules require custodians to report the sales this way on Form 1099-B.

The good news is there is a form with the missing information called the “Supplemental Information” form. It will include the adjusted cost basis not shown on the original 1099-B. The adjusted cost basis includes the ordinary income tax you paid (or will pay) for the vested shares. Fidelity has a helpful guide that explains this topic in further and visual detail – see here.


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Kevin Brady

About Kevin Brady, CFP®

Kevin is an advisor in our New York City office.

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