Taxation of Restricted Stock Units: A Breakdown for 2023

Introduction

Restricted stock units (RSUs) have become increasingly popular among companies as a way to compensate and retain employees. RSUs represent a contingent right to receive shares of company stock in the future, and their taxation is governed by a different set of rules compared to traditional stock options. This article delves into the nuances of RSU taxation, providing a comprehensive guide to help individuals understand their tax implications in 2023.

When Are RSUs Taxed?

RSUs are taxed differently depending on whether they are "vested" or "unvested":

• Vesting: Vesting refers to the process by which RSUs become non-forfeitable and subject to taxation. Typically, RSUs vest over a period of time, such as four years, with a portion of the RSUs vesting each year.
• Unvested: Unvested RSUs are not subject to taxation because they have not yet been earned.

Types of RSU Taxation

There are two main types of RSU taxation:

1. Ordinary Income Taxation

• When RSUs vest, their value is typically included in the employee's ordinary income for the year of vesting.
• This means that the employee will pay income taxes on the value of the vested RSUs at their ordinary income tax rate.

2. Alternative Minimum Tax (AMT)

• The AMT is a parallel tax system that imposes a minimum amount of tax on high-income individuals.
• RSUs can be subject to AMT if their vesting triggers a large increase in the employee's taxable income.

Calculating RSU Taxes

The amount of tax owed on RSUs depends on a number of factors, including:

• The value of the vested RSUs
• The employee's ordinary income tax rate
• The employee's AMT status

Ordinary Income Tax Calculation

The formula for calculating ordinary income tax on RSUs is:

Tax = Value of Vested RSUs x Ordinary Income Tax Rate

AMT Calculation

The AMT calculation for RSUs is more complex. It involves determining the employee's AMT income and applying a 26% or 28% AMT tax rate.

Qualified Small Business Stock (QSBS) Exclusion

In some cases, the sale of RSUs may qualify for the QSBS exclusion. This exclusion allows taxpayers to exclude up to $10 million of gain from the sale of qualified small business stock. To qualify, the company issuing the RSUs must meet certain requirements, such as being a C corporation with less than $50 million in gross assets.

Tax Planning Strategies

There are a number of tax planning strategies that individuals can use to minimize their tax liability on RSUs:

• Holding RSUs: Holding vested RSUs until the company's stock price increases can reduce the employee's overall tax liability. This is because the increase in stock price will result in a lower capital gains tax rate when the RSUs are eventually sold.
• Selling RSUs Gradually: Selling vested RSUs gradually over time can help avoid triggering AMT.
• Tax-Deferred Accounts: Vesting RSUs into a tax-deferred account, such as a 401(k), can defer taxes on the RSUs until retirement.

Conclusion

Taxation of RSUs can be a complex subject, but understanding the fundamentals is essential for individuals who receive RSUs as part of their compensation. By carefully considering the tax implications and employing appropriate tax planning strategies, individuals can minimize their tax liability and maximize their financial returns.