Last week, we discussed former President Trump's and Vice President Kamala Harris's proposed tax policies, including potential changes to ordinary income and capital gains tax rates, taxes on inheritance, and taxes on unrealized gains.
This week we cover restricted stock units (RSUs), with a focus on publicly traded RSUs. For many, restricted stock compensation is a large source of income and could overshadow their cash or salary compensation. In fact, it could be your largest source of income.
With potentially hundreds of thousands of dollars at stake over time, it’s crucial to understand how tax policy can affect you.
Specifically, you want to focus on two types of tax: ordinary income tax and capital gains tax. Today, we'll break down the RSU vesting process, how they're taxed, and strategies to manage your tax exposure.
What you need to know
As part of annual compensation packages and signing bonuses, companies make commitments to award employees with shares of stock in the future, subject to certain conditions. If you receive stock-based compensation, familiarize yourself with these key concepts:
The grant date is the day your company promises you RSUs. At this point, you don't actually own any shares.
The vesting schedule determines when you actually receive the shares. Common schedules include:
- Time-based: for example, 25% after one year, then 6.25% every quarter for three additional years.
- Performance-based: When company or individual goals are met.
The vesting date triggers a taxable event when you receive the shares.
Unlike stock that you buy in your brokerage account, the IRS treats any grant of RSUs as ordinary income, or part of your salary. Let's discuss what this means for your taxes.
Tax treatment of RSUs
Whatever tax rate you pay on your cash income, or your ordinary income tax rate, is what you pay immediately on your RSUs once they vest. How does this work? An example:
Let's say you work for META, your income tax rate is 30%, and you were granted 400 RSUs worth $300/share or $120,000 on January 1, 2024. A year later, 25% of the shares or 100 shares vest and the stock is now trading at $400/share.
When these RSUs vest, the total number of vested shares is initially reflected in the RSU account. However, your company usually sells a portion of these shares to cover the taxes due at vesting. After this tax withholding, the remaining shares (after-tax shares) are what remain in your account for you to hold or sell as you choose.
Thus, in this example, 70 shares with a value based on the current stock price of $400 and a value of $28,000 would remain in the account.
As long as you hold those 70 remaining shares, the value of them will fluctuate as market prices go up and down. Once you sell, any profit will be subject to capital gains tax. It’s crucial to note that the clock for calculating capital gains tax starts at the time of vesting, not the grant date.
If you sell in one month after vesting on January 31 at $450/share, you'll pay ordinary income tax on the $50/share profit since it's less than a year since the vest date. In this case, you'd likely be subject to the 30% income tax rate.
You would thus pay $1,050 in tax if you sold, calculated as follows: $50 profit x 70 shares x 30% ordinary income tax rate.
If you waited a year to sell, you would pay the long-term capital gains tax rate of 20% (or less for some people). Assuming the stock price stayed at $450/share, your tax would be $700, saving you $350.
However, with a larger stock price move, you could find yourself paying more in capital gains taxes.
Check your tax bracket
It's critical to be aware of your ordinary income and capital gains tax bracket so you can assess your potential taxes.
Your tax bracket (check here) affects both your ordinary income tax (which applies to RSUs at vesting) and potentially your capital gains tax rate.
As we recently shared, there is the potential for earners over $400,00 to face a higher rate under new proposals.
What should you do?
When it comes to RSUs, you can't do much about the ordinary income tax that will reduce your shares. However, you can take these other steps to manage your overall taxes, including your capital gains taxes:
- Evaluate the rest of your portfolio to determine opportunities to reduce your taxable income, including tax-loss harvesting.
- Be mindful of how stock grants could push you into higher ordinary income tax brackets in a given year.
- Evaluate your concentration in company stock. Also, balance out opportunities to purchase company stock at a discount through an employee stock purchase plan instead of holding onto vested shares.
- If you do hold onto the shares, assess your willingness to pay short-term capital gains vs. long-term capital gains. If you sell a portion of shares, choose lots wisely.
How can Mezzi help?
Mezzi is built to help you optimize your capital gains taxes, take advantage of ordinary income deductions, and avoid over-concentrating. By connecting your account with your RSUs, you can make smarter decisions regarding your company stock along with the rest of your portfolio.
Estimate your taxes and track loss carry forwards
Personalize Mezzi with your current or future tax rate. Track loss carry forwards and use them to reduce your tax burden.
Track unrealized gains & losses
Track short- and long-term unrealized gains and losses across accounts so you have a clear sense of how much tax you could expect to pay if you sold positions.
Tax-loss harvest
Sell positions with losses to offset your realized gains and maximize deductions against your income.
Taxable vs. tax-advantaged accounts
Easily track allocations, returns, diversification, and more for both taxable and tax-advantaged accounts with Mezzi.
