Solutions For Unpaid Taxes From Restricted Stock Units
Solutions For Paying Taxes on RSUs: Handling Unpaid Taxes From Restricted Stock Units
In an attempt to provide long-term incentives for employees, many employers have relied on stock-based compensation. Until recently, this primarily took the form of stock options. However, after the recent changes to accounting rules, some employers have instead provided restricted stock units, or RSUs, to their employees. The grant date is the specific date when RSUs are awarded to employees, which starts the vesting schedule. RSUs are used to incentivize employees and align their interests with the company’s success.
While usually simpler than other stock-sharing programs for employees to understand, RSUs still sometimes lead to confusion with respect to how they’re taxed. RSUs are a type of stock award, but unlike other stock awards such as restricted stock awards (RSAs) or performance stock awards (PSAs), RSUs do not require an upfront cost to the employee. In contrast, stock options may require employees to purchase shares at a set price. In some cases, this can lead to unexpected issues, like unpaid taxes. The goal of this article is to explain how RSUs work and what you can do to prevent a surprise tax bill. We’ll also discuss your options if the IRS has already assessed a tax balance that you can’t immediately pay.
Paying Taxes on RSUs: An Overview of Restricted Stock Units
RSUs represent a promise by an employer to give one or more shares of company stock to employees at a later time. An RSU, or restricted stock unit, is a form of equity compensation that grants employees the right to receive actual shares of company stock once certain conditions are met. RSUs are used to incentivize employees by aligning their interests with the company’s performance. RSUs are a type of stock award, distinct from other stock awards such as restricted stock awards, which may have different grant and vesting conditions. Unlike a stock option that gives the employee the option to purchase (or sell) shares of stock at a certain price, an RSU actually results in the employee receiving shares of stock (not just the option to buy them). Unlike stock options, RSUs do not have a strike price or exercise price, and they do not require any upfront cost from employees, making them more accessible than stock options. They are taxed differently. In the majority of cases, the transfer of stock with an RSU depends on one or more conditions, such as continuing employment with the employer for a minimum amount of time and/or meeting certain performance milestones.
In addition to the conditions required for RSU vesting, employers may also establish the timeline for when employees receive shares of stock. These timelines are known as vesting schedules, which determine when shares vest and employees receive their company shares. RSUs convert into actual shares at a future date specified by the vesting schedule. Vesting schedules can be time-based or performance-based. Most employers set up their RSU compensation packages so that they vest over three to five years.
Only after this vesting period has lapsed and the employee met any other vesting conditions will the employer transfer the shares to the employee. In most situations, employees receive their actual stock or actual shares immediately upon vesting. In other situations, the stock payout can occur sometime after the vesting date.
If you received compensation from your employer in the form of RSUs, you could have multiple taxable events to deal with. The first potential taxable event is when your RSU vests. At this point, the value of the shares is considered RSU income and must be reported as taxable income. RSU taxes are calculated at vesting and again at the time of sale, so understanding the timing and amount is important. At a minimum, payroll taxes such as FICA must be paid at this time. If you also receive your stock shares at the time of vesting (which is most common), then you’ll also owe income tax on the value of the stocks you receive. RSU income is treated as supplemental income and is taxed similarly to a cash bonus, but there is no immediate tax liability when RSUs are granted—taxation occurs when the shares vest. RSUs are taxed as ordinary income when they vest, and if you later sell the shares, any additional gain is taxed as capital gains.
In the majority of situations, the value of the stocks you get from your RSU will be the number of shares received multiplied by the fair market value of the shares when you receive them. The IRS and most state taxing authorities consider this amount to be ordinary income, so the taxes you’ll pay on them are based on your ordinary income tax rate. Ordinary income taxes are withheld from vested RSUs. You must report income from vested RSUs on your tax return.
If your employer transfers shares of stock after the vesting date, then typically only the payroll taxes are due at vesting. Then when you receive your shares of stock, that’s when you’ll pay your income taxes on them. Employers often withhold taxes at vesting (withholding tax), but the amount withheld may not fully cover your total tax obligation, so it’s important to review your situation.
Another potential taxable event could arise if you hold on to your shares after you receive them and they increase in value when you eventually sell them. If your employer did not withhold enough taxes at vesting, you may need to make estimated payments to avoid underpayment penalties.
If you decide to hold your company shares and sell them later, you may be subject to capital gains taxes on the stock appreciation. Capital gains taxes are taxed differently from ordinary income and depend on how long you hold the shares. When comparing RSUs to stock options, note that stock options allow employees to purchase shares at a set price, which can affect potential gains and risks.
How much you owe in capital gains depends on how long you wait to sell the shares. If you sell your shares within 12 months of receiving them, then you’ll pay the short-term capital gains tax rate. This is the same tax rate you pay on your regular paycheck. If you sell them more than a year after you get them from your employers, then you’ll pay the long-term capital gains rate, which can be up to 20% of your gain in stock price, but the tax is typically only 15% and if your income is below a certain threshold, long-term capital gains are taxed at 0%. When deciding whether to sell or hold company shares, consider your investment portfolio and cash flow needs, as these decisions can impact your overall financial strategy. It is important to evaluate the company’s stock and its performance when making decisions about selling vested RSUs.
For employees at private companies, private company RSUs may have different vesting and taxation rules compared to public company RSUs. Public company RSUs are typically valued at the fair market value on the vesting date, while private company RSUs may require a liquidity event to realize value. Some companies use double trigger RSUs, which require both a vesting event and a liquidity event (such as an IPO or acquisition) before shares are delivered and taxed.
When planning for taxes, it’s important to understand your tax obligation and consider strategies to maximize tax deduction opportunities, such as charitable contributions or bunching deductions in a single year.
In the context of vesting, terms like vested RSUs, vesting RSUs, RSU vests, and shares vest all refer to the process and timing when RSUs become fully owned by the employee and trigger tax events. The company’s stock price at the time of sale will impact the value of your RSUs and the amount of potential capital gains. If the stock price falls after your RSUs vest, your RSUs still retain value, unlike stock options which can become worthless if the stock price drops below the set price. When reporting your RSU income and related transactions, it is essential to accurately include them on your tax returns.
Types of Restricted Stock Units
Restricted stock units (RSUs) are not all created equal—there are different types, each with unique features and tax implications. The two most common forms are Single-Trigger RSUs and Double-Trigger RSUs. Single-Trigger RSUs require only one condition to be met, usually a time-based vesting schedule. These are most often found in publicly traded companies, where employees receive their stock units after a set period of employment.
Double-Trigger RSUs, on the other hand, are more common in private companies. These restricted stock units require two separate events before shares are delivered: typically, the employee must satisfy a time-based vesting schedule, and there must be a liquidity event, such as an initial public offering (IPO) or company acquisition. This means employees may not receive their company stock until both conditions are met, which can delay when tax obligations arise.
Understanding which type of restricted stock units RSUs you have is crucial for managing your equity compensation and planning for the tax implications. Double trigger RSUs, in particular, can affect when you recognize income and owe taxes, especially if your company is private and planning for an IPO. Knowing your RSU type helps you anticipate your tax obligations and make informed decisions about your restricted stock.
Restricted Stock Unit Vesting Schedules
The vesting schedule of your restricted stock units determines when you actually earn the right to receive company stock. The most common vesting schedule is time-based, where a set percentage of your stock units vest each year—often over a four-year period, starting from the grant date. For example, you might see 25% of your shares vest each year on the anniversary of your grant date.
Some companies use performance-based vesting schedules, where shares vest only if specific performance goals or milestones are achieved. Another approach is cliff vesting, where all your shares vest at once after a certain period, such as after three or four years of service.
Your vesting schedule directly impacts when you recognize taxable income from your RSUs, since you only owe taxes when shares vest. Understanding your vesting schedule helps you plan for when shares vest, how much taxable income you’ll report, and how to manage your tax obligations as your shares vest over time.
Why You Might Have an Unexpected Tax Bill Because of RSUs
How RSUs get taxed is relatively straightforward (as far as taxes are concerned). But why does this often lead to an unpleasant surprise during tax season? It’s most likely the result of your employer not withholding the necessary taxes when your RSUs vest and/or when you receive your shares. If your employer does not withhold taxes on your RSUs, you may have a larger tax obligation when it comes time to settle up with the IRS.
When your RSUs vest and your employer pays out your stock shares, there are three main ways for your employer to handle the tax withholdings. First, they can withhold all of your taxes for your regular paycheck, such as your portion of FICA and your income taxes—these are the taxes withheld at vesting. Second, they can withhold just some of the taxes you owe, which may result in insufficient taxes withheld and a potential tax bill later.
Third, they withhold none of the taxes you owe. As a result, you have to pay your portion of the payroll taxes (like FICA), plus the income taxes you owe. You owe these taxes at the time of vesting and the time you receive legal ownership of your shares. This means you’ll likely have to send estimated payments to the IRS in the quarter(s) your RSUs vest and you receive the stock. Estimated payments help you manage your tax obligation and avoid underpayment penalties, and if you don’t make them, you will owe money when you file your tax return.
It’s the second and third scenarios that can result in an unexpected tax bill. This is especially true if your employer doesn’t tell you it’s not withholding all of the taxes you owe. To avoid IRS penalties, it’s important to accurately report income from your RSUs and file taxes on time.
Understanding Cost Basis and Tax Implications of RSUs
Receiving restricted stock units (RSUs) as part of your equity compensation can be a valuable benefit, but it’s crucial to understand the cost basis and tax implications to avoid surprises at tax time. The cost basis of your RSUs is determined by the fair market value of your company’s stock on the vesting date—the moment when the stock units officially become yours. This fair market value is used to calculate the taxable income you must report on your tax return, and it forms the foundation for determining your future capital gains tax if you sell your shares.
When your RSUs vest, the value of the vested shares is treated as ordinary income. This means you owe ordinary income tax on the fair market value of the stock units at the time they vest, and this amount is included in your taxable income for the year. Your employer typically withholds income taxes and payroll taxes, but the withholding may not always cover your full tax liability, especially if you’re in a higher tax bracket or have other sources of income. It’s wise to review your tax withholding and consult a tax professional to ensure you’re meeting your tax obligations and won’t face an unexpected tax bill.
The cost basis becomes especially important when you decide to sell your vested shares. If you sell the shares for more than the fair market value at vesting, you’ll realize a capital gain, which is subject to capital gains tax. The length of time you hold the shares after vesting determines whether you pay short-term or long-term capital gains tax. If you hold the shares for more than a year, you may benefit from the lower long-term capital gains tax rate, which can help reduce your overall tax liability.
To manage your tax exposure, consider strategies such as selling a portion of your vested shares to cover your tax bill or using other investments to offset capital gains. Keeping detailed records of your RSU grants, vesting dates, and tax withholding is essential for accurate tax reporting and for calculating your cost basis and any capital gains or losses when you sell your shares. A financial advisor or tax advisor can help you develop a plan to minimize your tax liability and make the most of your equity compensation.
If you work for a private company, or if your RSUs are subject to double-trigger vesting—meaning you need both a vesting period and a liquidity event like an initial public offering (IPO)—the tax implications can be more complex. In these cases, the timing of when you recognize income and pay taxes may differ, and you should review your RSU agreement carefully. Consulting a tax professional is especially important to understand how restricted stock units are taxed in private companies and to plan for any additional taxes that may arise if your company goes public.
By understanding the cost basis and tax implications of your restricted stock units RSUs, you can avoid costly mistakes, ensure compliance with your tax obligations, and maximize the benefits of your company’s stock compensation.
How to Avoid a Surprise RSU Tax Bill from the IRS
You can prevent an unexpected tax balance stemming from your RSUs by talking with your employer. This discussion can include asking questions about the tax withholdings. For example, you can ask your employer how much of the RSU compensation they are withholding for taxes. If they’re not withholding enough, you can ask them to withhold a larger amount. If they decline to withhold enough, at least you now know that you’ll have taxes to pay when your RSUs vest and when you receive the shares.
Another thing to talk about with your employer is when you receive your shares of stock. Recall from earlier that most employers will distribute the shares at the same time the RSUs vest. But this isn’t always the case, especially if the employee requests otherwise.
In some cases, employers will be willing to delay when they transfer the shares of stock to their employees, even though the RSUs have already vested. For example, let’s say your RSUs vest on June 30 and your employer wants to pay out your shares on this date. However, you earn significant income and you plan on retiring at the end of the year.
Because your income next year will likely be lower than this year (as you’ll be retired next year), you might want your employer to wait until January 1 of the following year to disburse your shares. By doing so, you hope to pay less in income taxes as you’ll have a smaller income and therefore, you expect to be in a lower tax bracket.
There may also be other tax planning options available. The moment you learn about your RSUs, you should talk to your tax planning professional for advice on things you can do now, before your RSUs vest.
Deferring Taxes on Restricted Stock Units
For most employees, taxes on restricted stock units are due at vesting, based on the fair market value of the shares at that time. This means you generally cannot defer taxes on RSUs—the IRS treats the value of vested RSUs as ordinary income, and you’ll see this reflected in your tax bill for the year.
However, there are ways to manage your tax liability. Some employees choose to sell a portion of their vested RSUs immediately to cover the taxes owed, while others may use other sources of income to pay the tax bill. In rare cases, advanced strategies like hedging with options or other financial instruments may help defer taxes, but these approaches are complex and come with their own tax implications.
Because the rules around RSU taxation can be complicated, especially if you’re considering ways to defer taxes or manage a large tax bill, it’s wise to consult a tax professional. They can help you understand your options, estimate your tax liability, and develop a plan that fits your financial situation and goals.
What You Can Do If You Have Unpaid Taxes on Restricted Stock Units
If you find yourself in a situation where you’ve already received the unpleasant news of unpaid taxes, the first thing you should do is assess your situation. See if the IRS properly calculated your taxes and contact your compensation and benefits coordinator at work to see if there’s a mistake or misunderstanding somewhere. If your tax bill is large, review your financial situation to see how much cash you have immediately available to pay your taxes. Analyze your cash flow to determine how much you can allocate toward your tax bill. When reviewing your assets, consider your investment portfolio as a potential source for covering your tax obligation.
Assuming you’re sure that the tax bill from the IRS is correct, but you can’t pay it off in full right away, you can give the IRS a call to discuss your payment options. Depending on how much you owe and the basis for any penalties levied against you, you might be able to get an extension to pay off your tax debt and/or reduce or eliminate one of the penalties. Below are additional options to consider.
Decide When and If to Sell Your Shares
Many employees will sell all of their shares the same day they receive them from their employer. However, this isn’t required, and you might have decided to hold on to the shares or only sell some of them. After vesting, your RSU shares are typically deposited into a brokerage account, where you can manage your company shares or company stock. In this case, you can consider selling some or all of your remaining shares to cover your tax liability.
This decision will depend on various factors, such as other financial options for paying off the tax debt, whether the price of the stock has gone up or down since you received the shares, and in what direction you believe the stock price will go. Selling your shares may also result in capital gains taxes, depending on how long you have held the shares.
For instance, if you held on to your shares, but the stock price has fallen since you received them, then selling them will not only give you cash to pay off your taxes but the capital losses can be used to offset any taxable income you might have. Keep in mind there’s a limit to using capital losses to offset ordinary income, but you can offset all capital gains up to the value of your capital losses. Or if the stock price has gone up significantly, you might not want to sell as many shares, as some of the proceeds from the stock sale will be needed to pay the taxes you now owe on the gains you realized from selling.
Find Alternative Sources of Funding
You might have access to personal loans or lines of credit to help pay off your taxes. Maybe your home is paid off so a sizeable home equity line of credit is available. Or you have access to a credit card offer that charges you zero percent interest on cash advances. Other options include close family or friends you can borrow money from, selling property you already have, (like a car, boat, or personal property of significant value), and pulling money out of a savings or retirement account.
Be careful if pulling money from a savings or retirement account. Having access to an emergency fund could be worth paying interest to the IRS or there might be hefty financial penalties you have to pay for withdrawing from a retirement fund too early.
Pay Your RSU Tax Balance Over Time
If you’re like most taxpayers, this might be your most realistic option. You may have to pay interest or hire a tax professional to help you negotiate with the IRS or apply for a program. Yet these could be worthy costs if it means not having to sell your home or compromise your financial security. Some options to think about are:
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Offer in Compromise (OIC)
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Currently Not Collectible (CNC) Status
Get Professional Tax Help
You can sometimes deal with your tax debt to the IRS on your own. You can do your own research to figure out your best solution, then contact the IRS directly to set things up. A short-term payment plan is a good example of this.
If you need more time to pay, owe a significant amount of money to the IRS, and/or have significant financial struggles, then other options can provide more time and even reduce how much you owe. However, applying for these (such as the OIC and CNC Status) can be difficult to do without the help of a tax professional, such as a CPA or tax attorney.
Restricted Stock Unit Planning
Planning for your restricted stock units is essential to maximize their value and minimize your tax liability. Start by understanding how restricted stock units are taxed—at vesting, the fair market value of your company stock is treated as ordinary income, and you’ll owe income tax at your ordinary income tax rate. If you hold your shares for more than a year after vesting, any increase in value may qualify for long-term capital gains tax rates, which are typically lower than ordinary income tax rates.
To optimize your RSU benefits, consider your vesting schedules and the timing of when you sell your shares. Selling immediately after vesting can help cover your tax obligations, but holding shares for more than a year may reduce your capital gains taxes if the stock price rises. Diversifying your investment portfolio is also important—relying too heavily on company stock can increase your financial risk.
A financial advisor can help you create a personalized strategy for your RSUs, taking into account your tax obligations, investment goals, and risk tolerance. With careful planning, you can make the most of your restricted stock units, manage your tax liability, and build a stronger financial future.
Need Help Dealing with Taxes from Restricted Stock Units?
Whether you’re not sure how to deal with your RSU tax obligations or you just learned about a major tax bill, the tax pros at Damiens Law can help. We’ll start by helping you understand what’s going on and why. Then we’ll explain what your options are and which ones are most likely to help you the most. We offer free consultations, so you have nothing to lose by contacting us.
