3 Tax-Efficient Strategies for Managing RSUs

Restricted stock units (RSUs) can be a valuable form of equity compensation that significantly contributes to your financial well-being. Unlike stock options, RSUs are nearly always worth something when they vest since your employer grants them to you as part of your overall compensation package.

Unfortunately, failing to understand the tax implications of RSUs can lead to costly mistakes that diminish their potential value. Thus, it’s important to be aware of the tax treatment of RSUs, so you can manage your taxable burden and make the most of your equity compensation.

RSU Basics

RSUs are a form of equity compensation that grants employees the right to receive company stock at a future date. Typically, your vesting schedule—that is, the point in time when your RSUs become yours—is based on your time with the company or your ability to meet certain performance milestones.

When your RSUs vest, they’re considered taxable income based on their fair market value at that time. For example, if your employer grants you 1,000 shares of company stock and the stock is worth $50/share when your RSUs vest, your taxable income will increase by $50,000.

That $50,000 of additional income is subject to your ordinary income tax rate, including payroll taxes. When you sell your RSUs, any gain from the time they vest is subject to the capital gains tax. If you hold your shares for at least one year, you’ll pay the lower long-term capital gains rate.

Indeed, RSUs are becoming an increasingly popular form of equity compensation among employers in the United States. In a recent survey of 325 companies, 72% reported using RSUs to incentivize employees long-term compared to just 47% ten years earlier.

Yet maximizing the potential value of your equity compensation requires careful tax planning and, in many cases, expert guidance. Fortunately, there are several tax-efficient strategies that can help you make the most of your RSUs.

Consider the following tax-efficient strategies for managing your RSUs:

#1: Sell-to-Cover Approach

When your RSUs vest, you can sell a portion of your shares to cover the associated tax liability. This is also known as a sell-to-cover approach.

With this strategy, you avoid using personal funds to pay taxes. Meanwhile, you maintain ownership of a portion of your shares to benefit from potential future growth.

For example, suppose your employer grants you 100 shares of company stock worth $10/share when your RSUs vest. Since your tax withholding rate is 25%, you owe $250 of your equity compensation in federal taxes.

With a sell-to-cover strategy, your employer can choose to sell 25 of your 100 shares to cover the $250 tax. Then, you keep the remaining 75 shares with no additional income tax liability.

The main advantage of this approach is you don’t need to dip into your own cash reserves to cover the associated tax liability when your RSUs vest. Moreover, by retaining a portion of your shares, you can still benefit from your company’s future growth potential.

On the other hand, selling a portion of your shares when they vest reduces your upside potential. In addition, the sell-to-cover approach doesn’t address the tax implications of holding the remaining shares.

#2: Tax-Loss Harvesting

Tax-loss harvesting involves selling securities at a loss to offset your potential capital gains tax liability. This tax-efficient strategy for managing RSUs can be helpful if you wish to reduce your position in company stock over time.

However, it can also be useful if your shares of company stock have declined in value. By selling your shares at a loss, you can realize gains from other investments while reducing or eliminating your capital gains tax liability.

The primary benefit of tax-loss harvesting is that it allows you to reposition your overall investment portfolio and potentially reduce risk while minimizing the associated tax consequences. But keep in mind this strategy requires careful planning and oversight. In addition, tax-loss harvesting may involve transaction costs and potential market timing challenges.

#3: Disciplined Selling

The timing of when you sell your RSU shares can significantly impact your tax liability. If you have the time and patience, you may want to take a more disciplined approach to selling your shares of company stock over time.

By doing so, you can spread your potential tax liability over several years. This can be particularly advantageous if you anticipate your income to decline in future years, placing you in a lower tax bracket.

In addition, this approach gives you the opportunity to maximize your after-tax gain by selling your RSUs at a favorable market price. You may also be able to realize losses from other investments to further boost your earnings.

The downside of this strategy is that it has many unknowns, including your future income and the long-term performance of your company stock. Consider consulting with a fee-only financial planner or tax expert, who can help you determine if taking a disciplined selling approach makes sense for managing your RSUs.

Avoid These Pitfalls When Managing Your RSUs

Managing your RSUs with tax efficiency in mind is crucial to ensure you’re maximizing your equity compensation. Unfortunately, it’s easy to make costly mistakes that can diminish your potential earnings or put your financial well-being at risk.

Examples of common pitfalls include:

• Failing to proactively manage the tax implications of RSUs. As mentioned previously, RSUs are subject to both ordinary income taxes and capital gains taxes. Thus, a lack of planning can result in an outsized tax liability, which may force you to liquidate other assets to cover.
• Forgetting to adjust your cost basis. The cost basis of your RSUs is essential for calculating capital gains taxes when you ultimately sell your shares. Employees with RSUs sometimes forget to adjust their cost basis to their fair market value at vesting. This can result in overpaying capital gains taxes.
• Accumulating a concentrated position in company stock. Over-concentrating your investment portfolio in company stock as your RSUs vest can be risky, as it ties a significant portion of your net worth to the performance of one asset. Meanwhile, diversifying a concentrated stock position can also have serious tax consequences if you don’t take a strategic approach.

Familiarizing yourself with the tax implications of RSUs is the first step toward maximizing your equity compensation. However, working with a financial professional with expertise in various types of equity compensation can also help you avoid many of the common pitfalls associated with RSUs.

SageMint Wealth Can Help You Identify Tax-Efficient Strategies for Managing Your RSUs

While the strategies mentioned above provide a solid foundation for tax efficient RSU management, it’s important to remember that everyone’s financial situation is unique. A fee-only financial planner or tax professional who specializes in equity compensation can help you develop a personalized approach based on your specific needs and financial goals.

SageMint Wealth specializes in helping clients navigate the complexities of equity compensation within the context of their long-term financial plan. We can help you develop a tax-efficient strategy for managing your RSUs with the goal of maximizing your potential earnings and overall financial well-being. To learn more about how we help our clients make the most of their hard-earned wealth, please contact us.