When you think about compensation in a job, you probably focus on salary. It’s predictable, guaranteed so long as you keep your job, and likely the foundation of your household budgeting.
But there are other ways some employers choose to compensate or reward employees: restricted stock units (RSUs), stock options, outright grants of company shares, and more.
These methods are less predictable, not necessarily guaranteed, and more complicated in terms of things like timing, taxes, and costs.
What are restricted stock units?
RSUs are a grant from the company to employees; the grant’s value is based on the underlying value of the company’s stock.
Stock-based compensation provides employers with a way to help build employee loyalty and motivation and tie their compensation to the success of the company. In other words, it helps ensure that employees have skin in the game.
Grants may be awarded across the board, to everyone in a particular business unit, or tied to certain goals or objectives as an incentive to increase performance.
While public companies have public shares that are traded on a public stock exchange, private companies can also issue shares and grant them to employees.
Vesting over time
RSUs typically vest over time. That means that while the shares may be granted on X date, you, the employee, don’t actually own those shares until a specified point in time in the future.
Let’s say you were granted 100 shares of company stock on January 1, 2025, with 25% of the shares vesting each year after that. On January 1, 2026, you’d own 25 shares; on January 1, 2027, you’d own 50 (assuming you hadn’t sold any previously vesting shares).
A vesting schedule helps build employee loyalty, because leaving the company typically means you lose unvested shares.
Vesting can sometimes be accelerated. For example, if a company is offering some employees an early retirement package, they may accelerate the vesting on RSUs as an incentive to get targeted employees to accept the early retirement package.
Taxes
Taxes are where RSUs can trip some people up. You aren’t taxed when you get the grant; rather, you’re taxed when your shares vest and you receive ownership of them.
The taxable amount is based upon the market value of the shares on the date they vest and are awarded to you. That market value will count as ordinary income, just like your salary or a cash bonus.
Some companies withhold taxes on this income, and that withholding may be paid via a portion of the shares received, by paying cash out of pocket, or other methods. Both the market value and the tax withholdings will be reported on year-end tax documents to the IRS.
The other time to pay attention to taxes is when you sell shares. The market value when they vested is the cost basis, and you’ll pay taxes on any gains via either long-term or short-term capital gains tax. Any losses can offset any other investment gains you may have realized during the year.
What are stock options?
Stock options are another common form of stock-based compensation. Stock options provide the employees receiving them with the right, but not the obligation, to exercise the options to acquire shares of company stock. They’re often given upon hiring.
In the case of options, the ability to exercise the option is based on a stated share price for the stock when the options are granted.
For example, let’s say your employer gave you 100 stock options at $5/share with a five year deadline for exercising them. Nearly five years later, the stock price is $25/share. Your options would allow you to buy 100 shares of $25/share stock for only $5/share.
But let’s say nearly five years later the stock price is $3/share. You could buy shares either on the open market (for a public company) or an internal market (for a private company) for $3/share instead, letting your options expire unexercised.
From a tax perspective, stock options work very much like trading securities on the open market. The cost basis is the price you paid for them, and you’ll be taxed on any capital gains you recognize when you sell them.
Things to keep in mind
Unlike salary and benefits, stock-based compensation happens intermittently, if at all. Because of that, it can be challenging to manage the ins and outs.
Here are a few things to keep in mind:
- Pay attention to the vesting schedule (RSUs) or the options expiration date. This will help you know when you need to turn your attention to your stock-based compensation, including managing any taxes you’ve accrued.
- Try to keep any vested or exercised stocks for at least a year before selling. Long-term capital gains taxes are typically much less than the short-term capital gains tax would be on the same sale.
- If you’re considering leaving the company, think about how much your unvested shares or unexercised options are and whether it’s worth walking away from them.
- Vested RSUs and exercised stock options are part of your investment portfolio. Consider how you might balance a (potentially) substantial investment in one company with a diversified portfolio.
Stock-based compensation is a nice problem to have, especially when you’re on top of the details.
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