Restricted Stock Units, also known as an RSUs, are compensation packages provided to employees in the form of stock. RSUs have become fairly common in publicly traded companies but also in companies that have ambitions of declaring an initial public offering (IPO) and trading their company stock on public exchanges. RSUs are recognized as income and increase W-2 income in the year the stock vests and is available for sale. The difference in what you can do with these RSUs does change a bit between public and privately held companies.
In publicly held companies; like Apple and Netflix, the RSUs are provided to employees on a vesting schedule. Typically, the RSUs are awarded with a certain number of shares unvested (withheld for a later vesting date) and on the anniversary of the first year of employment some shares will become vested. Once the stock is vested, the employee owns those shares outright. Then the question is whether to hold the stock or to liquidate; this is usually done through an analysis of the upside of the company and whether it makes sense to hold the stock for the long term or reduce your risk by converting the stock to cash. Upon vesting of the first lot, often the remaining lots vest monthly. It is possible to receive more RSU awards in future years subject to new vesting schedules. From the company’s standpoint, the RSUs are a way of rewarding and retaining employees for their service.
In privately held companies, RSUs can still be a form of compensation. However, in most of these cases, the RSUs are subject to a double-trigger event. The RSUs must vest but then also be recognized in an IPO or an event recognized in the plan policy. This means while the RSUs may vest in a private company, they may not have any value until the company has gone public. This double-trigger event is done to protect employees from having to pay taxes when the RSUs vest while there is no available market to sell the shares.
There are privately held companies that don’t use the double trigger event; however, it is pretty rare and typically the plan has a mechanism for the employee to sell enough shares to cover the taxes. If the plan doesn’t have a mechanism to pay the taxes, then there may be an 83i election to make. It is a bit complicated, but it involves paying taxes on the unvested stock while the price is lower (pre-IPO). This can help reduce the overall tax burden, but it can come with a large tax bill earlier than if the RSU taxes were paid as the lots vested. The 83i election isn’t used often and the company must meet certain qualifications. However, if you are in the position of having a privately held company without a double trigger event in the plan, you may want to review this option within 30 days of the RSUs vesting.
In summary, these RSU packages can be a nice incentive for employees to stay with their employer longer and participate in the upside value of the company. The lots that do vest and are subject to tax often are run through payroll with a mandatory withholding of 22% federal tax. We do see that flat withholding rates cause problems for some clients. It is important to understand when your lots vest and for how much. Furthermore, you want to evaluate how much of your net worth you want to have in these RSU packages. Sometimes the value of the RSUs is significant and a coordinated diversification and tax plan is needed. If the company's upside seems limited, then it may make sense to sell the RSUs as they vest – of course, if the upside of the company is limited then there may be a broader question of what the RSU package is really providing. Be aware that if you leave a company your unvested portion of stock is subject to a company-specific policy. You could lose your RSUs, or they may be bought out at a listed rate. So, it is important to know these details before making any moves.