What Are RSU Options? A Comparison to Stock Options

Restricted Stock Units (RSUs) represent a form of equity compensation provided to employees, signifying a promise from a company to deliver its stock or its cash equivalent in the future. These units are not actual shares at the time of grant; instead, they are a contractual right to receive shares once specific conditions are satisfied. Companies frequently utilize RSUs as a tool to attract, retain, and incentivize talent, aligning employee interests with the long-term success and growth of the business. The structure of RSUs differs significantly from traditional stock options, which grant the right to purchase shares, not the shares themselves.

Understanding Restricted Stock Units

RSUs are granted as a promise of shares, which remain “restricted” until vesting requirements are met. Vesting is when an employee gains full ownership. Until then, the employee typically lacks voting rights or dividends.

Common vesting schedules include time-based vesting, requiring an employee to remain with the company for a set period. This can be cliff vesting (all units vest at once) or graded vesting (portions vest incrementally). Performance-based vesting ties unit release to company or individual milestones, like revenue targets.

Once vesting conditions are met, the restricted status is removed, and shares are delivered. This converts the RSU into actual company stock, granting the employee full ownership rights, including the ability to sell or vote. The shares’ value is determined by the company’s fair market value on the vesting date.

Tax Implications of Restricted Stock Units

RSU tax treatment is important for recipients. At grant, there is generally no taxable event, as units are a promise of future shares, not realized income.

The primary taxable event occurs at vesting, when restrictions lapse and shares are delivered. The fair market value of vested shares is considered ordinary income, subject to federal, Social Security, and Medicare taxes. For instance, if 100 shares vest at $50 each, $5,000 is added to the employee’s ordinary income.

Employers typically manage tax withholding at vesting using “sell-to-cover,” where a portion of vested shares is sold to cover estimated tax liability. This withholding includes federal, state, and payroll taxes. Employees may also pay cash to cover taxes, retaining all vested shares.

If vested shares are held and later sold, any gain or loss from vesting to sale is a capital gain or loss. Selling within one year results in short-term capital gains, taxed at ordinary income rates. Holding over one year yields long-term capital gains, typically taxed at a lower rate. The cost basis is the fair market value on the vesting date.

Comparing RSUs and Stock Options

RSUs and stock options are both equity compensation, but differ in nature. RSUs are a promise of actual company shares delivered upon vesting, requiring no purchase. Once vested, RSUs always hold value, provided the stock price is above zero.

Stock options, conversely, grant the right to purchase shares at a predetermined exercise price within a set timeframe. Employees must pay this price to acquire shares. Options only hold value if the stock price exceeds the exercise price; otherwise, they can become “underwater” and worthless.

RSUs are granted at no direct cost, as employees receive shares upon vesting. Stock options require capital outlay to exercise. This impacts employee financial commitment. RSUs offer predictable value, while options carry higher risk but potential for substantial gains if the stock price appreciates.

Taxation differs significantly. RSUs are taxed as ordinary income at fair market value upon vesting. For non-qualified stock options (NSOs), the tax event typically occurs at exercise, with the difference between market and exercise price taxed as ordinary income. Incentive Stock Options (ISOs) have more complex tax rules, potentially offering capital gains treatment upon sale, but can trigger the Alternative Minimum Tax (AMT).

Managing Vested Shares

Once RSUs vest and shares are delivered, employees gain full control. A common strategy is to sell the vested shares immediately. This diversifies the investment portfolio and reduces concentration risk in a single company’s stock.

Selling immediately simplifies tax planning, as taxable income from vesting is based on fair market value at that time. Selling right away minimizes additional capital gains or losses, as the sale price is close to the vesting price. This provides cash for other financial goals.

Alternatively, employees may hold vested shares for potential future capital appreciation. However, holding company stock means continued exposure to company-specific risk, which can lead to depreciation. It is advisable to avoid an overly concentrated position in a single stock.

When holding shares after vesting, consider capital gains implications upon sale. Holding over one year from vesting results in long-term capital gains, taxed at lower rates. Selling within one year means short-term capital gains, taxed at ordinary income rates.