Do Restricted Stock Units Have a Strike Price?

Restricted Stock Units (RSUs) are a common form of equity compensation used by companies to attract and retain talent. This article clarifies how RSUs function and addresses whether they involve a “strike price,” a term often associated with other equity vehicles.

Understanding Restricted Stock Units

Restricted Stock Units represent a promise from an employer to deliver shares of the company’s stock to an employee once specific conditions are fulfilled. These conditions typically involve a vesting schedule, which can be time-based (requiring the employee to remain with the company for a set period) or performance-based (tied to achieving certain milestones). Once these restrictions are met, the RSUs vest, and the employee receives the actual shares or their cash equivalent.

During the vesting period, the employee does not yet own the shares, and they generally hold no voting rights or dividend entitlements. Upon successful vesting, ownership of the shares transfers to the employee without any purchase price required. The value the employee receives is typically the full market value of the shares on the vesting date.

RSUs Versus Stock Options

A distinction in equity compensation lies between Restricted Stock Units and stock options, particularly concerning the concept of a “strike price.” Restricted Stock Units do not have a strike price. They represent a direct grant of company shares upon vesting, meaning the employee does not pay anything to acquire the stock. The value of an RSU is tied directly to the market price of the company’s stock when it vests.

In contrast, stock options grant an employee the right, but not the obligation, to purchase a company’s shares at a predetermined price, known as the “strike price” or “exercise price,” within a specified timeframe. This strike price is typically set at the fair market value of the stock on the grant date. Employees realize value from stock options only if the market price of the stock rises above this strike price. If the stock price falls below the strike price, the options may become worthless.

With RSUs, shares are simply delivered to the employee once vesting conditions are satisfied, without any payment from the employee. RSUs inherently hold value as long as the underlying company stock has any market value above zero, offering more certainty than stock options, which depend on stock price appreciation above the strike price to be profitable.

Taxation of RSUs

The taxation of Restricted Stock Units involves specific events that trigger income recognition for the employee. The primary tax event occurs at vesting, when the fair market value of the shares on the vesting date is treated as ordinary income. This income is subject to federal income tax, state and local income taxes, and Federal Insurance Contributions Act (FICA) taxes, which include Social Security and Medicare. Employers typically withhold a portion of the vested shares or cash to cover these tax obligations, often through a “sell-to-cover” method.

For federal income tax purposes, the withheld amount for supplemental wages, such as RSU income, is commonly 22% for amounts up to $1 million, and 37% for amounts exceeding $1 million. An employee’s actual tax rate might be higher than the default withholding, potentially leading to additional tax liability at filing time. FICA taxes also apply to the RSU income at vesting.

A second tax event occurs if the employee later sells the vested shares. Any difference between the sale price and the fair market value at vesting, which establishes the cost basis for tax purposes, is subject to capital gains or losses. If the shares are sold within one year of the vesting date, any gain is considered a short-term capital gain and is taxed at the employee’s ordinary income tax rate. If the shares are held for more than one year after vesting before being sold, any gain is classified as a long-term capital gain, which is generally taxed at more favorable rates.