What Are RSUs: A Fundamental Guide for the Equity Professional

Understanding restricted stock units can often be a daunting task for many stock plan administrators, particularly those new to equity compensation. RSUs can represent a significant part of an employee’s compensation package, and an understanding of their nuances, especially their tax implications, is imperative for any equity professional. 

RSUs are a form of equity compensation granted by employers to their employees. Each RSU represents one share of the company's stock. However, these units only hold value when they "vest," i.e., when an employee fulfills the terms as stated in their agreement, which is typically linked to a specified period of continued employment or some form of clearly defined performance criteria. 

During the vesting period, RSUs are considered "unearned" and hence carry no voting rights, nor do they offer dividends (though their equivalents or “DEUs” may be offered). Most companies pay out RSUs upon vesting, which means that once vested, the RSUs become actual shares, bestowing upon the employee all the privileges of a shareholder. 

In some cases, RSUs can be subject to deferred payout, meaning that they aren’t paid upon vesting. They might be paid out on a specified date, a specified number of years after vesting, or when the award holder terminates employment. This type of RSU arrangement, which is not as common as RSUs that are paid out upon vesting, is beyond the scope of my blog entry for today, but you can learn more about it in the article Deferred Stock Units. 

Understanding the tax implications of an RSU is critical. Understanding the tax implications of an RSU is critical. When an RSU vests, the participant will recognize compensation income subject to federal and state income taxes, with the fair market value at the time of vesting being used to calculate the ordinary income element of the award. Employers are obligated to withhold taxes on this income and report it on the employee's Form W-2. 

Later, when employees decide to sell their shares, any gain or loss relative to the FMV at the time of vest will be treated as a capital gain or loss, and this amount will be taxed at either long-term or short-term rates, depending on how long the shares were held after release. The employer has no withholding or reporting obligations for any capital gains income employees may earn after vest; employees are responsible for reporting and paying taxes on capital gains when filing their tax returns. 

 

It is essential, however, to note that these tax rules apply predominantly in the U.S, as international employees could face different tax consequences.  

 

To further explore this topic, we implore you to check out this article on Taxable Events for RSUs. 

From a tax perspective, RSUs and stock options also differ. Unlike RSUs, which are typically taxed at the time of vesting, stock options are taxed at the date of exercise if NSOs, and at the time of sale if ISOs, thus offering the employee more control over when that taxation event will occur.  

Full value awards such as RSUs have seen a substantial rise in popularity over the years, and for those looking to gain further insight into this trend, please refer to our post “4 Trends in Equity Award Usage and Eligibility”.  

 

RSUs hold special significance in private companies, especially startups. Here, RSUs are commonly used to attract and retain talent by offering potential wealth, which can be a powerful motivator. However, in the absence of a public market, selling these shares to realize that wealth can be a challenge. The holder might need to wait until the company goes public (through an IPO), until a third-party buyer is found, or a reverse tender offer is conducted by the company. 

Moreover, it's important to remember that RSUs in private companies will sometimes be subjected to additional vesting conditions, such as "double trigger" vesting, where an RSU will vest not only based on time or performance, but also upon a significant corporate event like an IPO or a sale of the company. 

  

The reason for this relates back to the illiquid nature of private markets, and the tax implications that occur when an equity award is no longer at a substantial risk of forfeiture.  A double-trigger vesting condition in essence delays that taxation event and prevents the employee from being taxed on an award that they most likely will not be able to receive immediate financial gain from.  

As a stock plan administrator, your role is pivotal in managing RSUs. Here are some strategies to help you handle RSUs effectively.  

Communication: Keeping employees informed about their vesting schedules and tax implications can alleviate a lot of confusion and potential frustration. 5 Tips for Communicating with Stock Plan Participants. 

Tracking RSUs: Efficiently managing vesting schedules, tax withholdings, and employee terminations can significantly reduce administrative overheads and potential mistakes.  Increase Your Equity Plan Management Efficiency 

Understanding Regulations: Staying updated with IRS rules and regulations related to RSUs will help ensure that the company remains compliant and can avoid any penalties. See our Guide to Restricted Stock and Unit Plans for a discussion of all the rules and regulations that apply to RSUs. 

Helping Employees Understand RSUs: While you can't provide personal financial advice, informing employees of the risks associated with equity compensation will allow them to make informed decisions concerning their awards.  Check out our resources on Participant Education. 

Continuous Learning: RSUs, like any aspect of equity compensation, will evolve over time. As a stock plan administrator, staying on top of these changes can help you better manage your company's equity incentive plan and stay in tune with current industry trends. Attend this year’s NASPP Conference for the latest news and developments in equity compensation. 

If you are interested in delving deeper into RSUs, we at the NASPP have designed our on-demand course “Restricted Stock Unit Essentials” to provide a higher level and more detailed understanding of the intricacies of RSUs and encourage the participation of all professionals within the space. 

RSUs are a powerful tool for companies to incentivize and reward their employees. By understanding their nuances and effectively managing them, stock plan administrators can play a significant role in the successful implementation of RSUs into a company’s equity compensation plan.  

Remember, each company's situation is unique, and the strategies and processes used to administer RSUs should align with the company's specific needs and objectives. Whether it's deciding between RSUs and stock options, understanding tax implications, or managing RSU plans in private companies, each decision should be made with careful consideration of all relevant factors. 

By continuing to educate ourselves and adapt to the ever-changing landscape of equity compensation, we as a community can better serve our companies and the employees that drive their success forward.