What Is a Restricted Stock Unit Benefit?

Restricted Stock Units (RSUs) have become a common component of employee compensation packages. An RSU represents a promise from an employer to grant shares of company stock to an employee in the future. This form of compensation serves as a means for companies to reward employees and align their financial interests with the company’s long-term success.

Understanding Restricted Stock Units

A Restricted Stock Unit (RSU) is a form of equity compensation that companies grant to employees, representing a promise to deliver shares of the company’s stock at a future date. Unlike stock options, RSUs do not require the employee to purchase the shares; instead, they are received at no direct cost to the employee. The “restricted” aspect signifies that the shares are not immediately owned by the employee upon grant. Full ownership is contingent upon meeting specific conditions, typically related to continued employment or the achievement of performance milestones.

Companies often utilize RSUs to attract and retain talent, fostering a sense of ownership among employees. By linking employee compensation to the company’s stock performance, RSUs aim to motivate individuals to contribute to the organization’s growth and profitability. The date an RSU is initially awarded to an employee is known as the “grant date.” On the grant date, the employee does not yet own any shares of the company’s stock. Instead, the RSU represents a contractual right to receive shares in the future, provided certain conditions are met.

The RSU Vesting Process

Vesting is the process through which an employee earns full ownership of their Restricted Stock Units. It involves meeting specific conditions, most commonly continued employment for a set period, or less frequently, achieving certain performance targets. Until an RSU vests, the employee does not have full rights to the underlying stock and cannot sell or transfer it.

Vesting schedules vary, but common structures include “cliff” vesting and “graded” vesting. With cliff vesting, all granted RSUs vest at once after a specified period, often one year. For example, an employee might receive a grant of RSUs that fully vest after two or three years of continuous service. Graded vesting, conversely, releases a portion of the RSUs periodically over several years, such as 25% each year over a four-year period. Some plans may also combine these, featuring an initial cliff followed by graded vesting.

On the “vesting date,” the conditions are met, and the RSUs convert into actual shares of company stock. These shares are typically delivered to the employee’s brokerage account. The value of the RSU at vesting is determined by the fair market value of the company’s stock on that specific date.

Taxation of RSU Benefits

The taxation of Restricted Stock Units primarily occurs at two distinct stages: at vesting and upon the subsequent sale of the shares. Understanding these tax implications is essential for comprehending the net value of an RSU benefit. The Internal Revenue Service (IRS) considers the value of vested RSUs as taxable income.

At vesting, the fair market value of the shares on the vesting date is treated as ordinary income to the employee. This income is subject to federal income tax, as well as Social Security and Medicare taxes (FICA taxes), similar to regular wages or a cash bonus. Employers typically withhold a portion of the vested shares to cover these tax obligations. This process, often referred to as “sell-to-cover,” results in the employee receiving a net number of shares after the tax withholding has occurred. For federal income tax, the withholding rate for supplemental wages, which includes RSU income, is commonly 22% for amounts under $1 million, though the actual tax owed may be higher depending on the employee’s overall income and tax bracket.

After the shares have vested and taxes have been paid or withheld, the employee owns the shares outright. If the employee chooses to sell these shares at a later date, any gain or loss from the vesting date market value is subject to capital gains tax. If the shares are sold within one year of the vesting date, any profit is considered a short-term capital gain and is taxed at the employee’s ordinary income tax rate. Conversely, if the shares are held for more than one year after vesting before being sold, any profit is considered a long-term capital gain, which is typically taxed at more favorable lower rates (e.g., 0%, 15%, or 20% depending on income). The cost basis for calculating capital gains is the fair market value of the shares on the vesting date.