If you work in technology, you've received RSU grants. You know it's a good thing, but the details might be a little fuzzy - especially about how they're taxed.
The concept of an RSU you might already understand…
Your company grants you some RSUs. Your RSU caterpillars spin their cocoons. And at a predetermined time in the future, they emerge as big, beautiful butterflies of your company stock.
For example, they give you 100 RSUs and a year from now 25% vest. At that point 25 RSUs turn into 25 shares of company stock which you can keep or sell (and then rest will vest over time, usually monthly).
So it makes sense why they're called Restricted Stock Units. They're "Restricted" because they aren't really yours until they vest. And they're "Stock Units" because they’re not really shares of your company stock.
They could have called them "Not-Quite-Yours-Stock-Things", but Restricted Stock Units sounds more grown-up.
Maybe you understood that part. Where we get the most questions is how they are taxed.
All the magic happens when they turn into butterflies. Before that, no one but you is paying attention. Uncle Sam doesn't care about your "Not-Quite-Yours-Stock-Things" because they aren't actually worth anything.
But when they emerge as butterflies, then he'll come collecting. Then they are worth some money, not a promise of future money. And since it's money you earned by working there, it will be taxed as ordinary income.
1. 25 RSUs vest today.
2. Your company stock is trading at $100 today.
3. Therefore $2500 will be reported as income on your W2 for this year.
The $2500 reported as income then becomes your cost basis. And how much you sell them for will determine your capital gains.
Back to our example:
5. $2500 is reported as income and is now your cost basis.
6. Later you sell your shares for $3,000.
7. Your capital gains is $500.
8. You'll pay capital gains tax on that $500.
And whether you pay long-term or short-term capital gains is determined by:
1) the day they vest and
2) the day you sell
If you sell them more than 12 months after they vest, you pay long-term capital gains of 15%. If you sell them sooner than 12 months after they vest, you pay short-term capital gains which is your ordinary-income rate.
To recap, RSUs are promises of future shares. On the day they vest, the fair market value becomes your cost basis and will get recognized as ordinary income. When you sell them, you will pay capital gains on the difference between the cost basis and what you sell them for. And you'll pay either long-term or short-term capital gains depending on when you sell them - whether you sell them before or after 12 months from the date they vest.
We encourage our members to think of RSU grants as simply additional compensation and sell them the day they vest. But that's a conversation to have with your own financial planner.
See? Not-Quite-Yours-Stock-Things aren't that complicated after all. They're just caterpillars turning into butterflies.