The Differences Between Selling RSUs for Cash and Taking Company Shares
When a Restricted Stock Unit (RSU) grant is settled, individuals receive the option to take either the cash equivalent of the shares, less ordinary income tax, or the equivalent net of taxes in shares. This decision can significantly impact your financial and tax situation going forward. Let's explore the key differences and considerations.
Understanding RSUs and Settlement
RSUs are employee stock rights granted by companies as part of their compensation packages. When RSUs vest, the company is required to deliver a corresponding number of shares. During settlement, the issuer typically withholds taxes, and the employee has two options: receive the shares or the equivalent cash value with taxes deducted.
Options for RSU Settlement
Option 1: Selling RSUs for Cash
Cash Equivalent of Shares: In this option, the employee receives the shares and sells them for cash. The proceeds are subject to ordinary income tax and, depending on the jurisdiction, capital gains tax if the shares are held for less than a year.
Option 2: Taking Company Shares
Net of Tax Shares: Another option is to take the shares net of taxes. This means the company withholds taxes at the time of settlement, and the employee receives the remaining shares free of withholding. However, the employee is still responsible for reporting the value of the shares at the time of receipt for tax purposes.
Benefits and Issues of Each Option
Issue 1: Fractional Shares and Tax Efficiency
Fractional Shares: Shares can only be delivered in whole numbers, so the company may round in the employee's favor. This can result in a minor tax advantage, as the employee pays slightly less in ordinary income tax. However, this minor tax advantage may be offset by the requirement to pay the difference when filing annual taxes. Nonetheless, the fraction of a share at settlement typically has a small impact on future financial implications.
Issue 2: Taxation on Share Value
Pre-Settlement Taxation: If the employee chooses to take the shares, they avoid immediate taxation on the value of the shares. The withholding tax at settlement covers the federal, state, and local taxes due on the grant's FMV (Fair Market Value) up to the settlement date. As a result, any growth in share value beyond the initial FMV is only taxed at the capital gains rate when sold.
Issue 3: Long-Term Tax Implications
Long-Term Capital Gains: If held for at least a year, any gains on the shares beyond the initial FMV will be taxed at the lower long-term capital gains rate. This can be particularly beneficial for equity-holders, as capital gains rates are typically lower than ordinary income rates. Furthermore, any capital losses can be offset against these gains at any time, providing flexibility in tax management.
Issue 4: Potential Sale at Lower Prices
Final Sale Price: If the shares are sold at a price lower than the initial FMV at settlement, the lower sale price will be subject to capital gains or losses. However, the impact of choosing to receive shares instead of cash is that the employee avoids immediate tax liability on the initial share value. This can be advantageous if market conditions are unfavorable, as it allows the employee to wait for potentially better selling prices in the future.
Strategies for Maximizing Value
While both options have their merits, the choice ultimately depends on the individual's financial situation, tax strategy, and market conditions. Here are some strategies to consider:
Strategic Timing
Avoid immediate taxes by taking shares, and wait for the right market conditions before selling. This can minimize short-term tax liability and potentially realize long-term capital gains.
Tax Planning
Engage with a tax advisor to understand the tax implications of each option and create a comprehensive tax plan. This can include offsetting capital losses, utilizing tax-efficient investment strategies, and maximizing deductions.
Dividend Considerations
If the company declares dividends, having shares can be advantageous as you receive dividends tax-free up to the FMV. However, this does not apply to the dividend on shares realized from selling RSUs.
Conclusion
The decision to sell RSUs for cash or take company shares is a critical one, and the implications extend beyond immediate tax liability. It's essential to carefully evaluate the short-term versus long-term tax strategies, market conditions, and individual financial goals. Consulting with a tax advisor or financial professional can provide tailored advice to optimize your RSU decision and maximize your overall financial benefits.
Additional Resources
For a deeper dive into RSU taxation, consider reviewing the following resources:
IRS Publication 525: Pertaining to Taxes on Income Compensation Section of the Advisor’s Compliance Manual Guide to Employee Stock Ownership