Six Things to Know About Restricted Stock Units

An employee’s total remuneration package may include many equity- or stock-based benefits. Each type of incentive  has its own set of rules governing how equity is managed, granted, and taxed. A commonly used incentive is restricted stock units.

Restricted stock units (RSUs) promise employees future benefits based on the value of the company’s stock when the restricted stock vests. Employees must understand the complexities of a restricted stock unit to get the maximum benefit.

In this article, we shall discuss some of the things employees need to know about their restricted stock units.

What Are Restricted Stock Units?

Restricted stock units is a  stock-based compensation awarded to employees.

Later-stage startups usually offer restricted stock units. A restricted stock unit will vest over a specific period, after which the employee can access it and do as they please.

Restricted stock units could be time-based or performance-based. It is typical to have a four-year time-based restricted stock unit, where employees are rewarded for remaining with the company for a specified duration.

Things Employees Must Know About Restricted Stock Units

Careful planning is necessary for employees to benefit the most from restricted stock units and equity compensation.

Below are six things that an employee must be aware of regarding restricted stock units

1. Vesting schedule

Like employer contributions to 401(k) accounts, restricted stock units do not belong to employees until vested. Suppose the employee works for a publicly traded company. In that case, the restricted stock units will either vest according to a “cliff” schedule (where 100% of the restricted stock units will become fully vested at once after a certain period) or a “graded” schedule (where the RSUs will become fully vested gradually, for example, at a rate of 25% per year and vested in four years), or a combination of both).

Moreover, an employee who works for a private company can run into a vesting schedule known as a double-trigger. Even if the employee satisfies the normal cliff and/or graded schedule requirements, the restricted stock unit will not become vested unless a specific liquidity event occurs. An initial public offering (IPO) is the most common type of liquidity event.

Some restricted stock unit plans could include additional vesting provisions related to the company’s specific performance metrics. Employees must make sure they fully understand the features if it does have additional features.

However, an employee needs to comprehend what will happen to both the vested and unvested restricted stock units if the employee leaves the firm. It could be beneficial to stay until more restricted stock units are vested.

2. Delivery date

Restricted stock units will be subject to tax at delivery rather than grant or vesting. Under most restricted stock unit plans, the shares are delivered to employees at vesting.

However, some restricted stock unit plans allow employees to postpone the share delivery to a later time. In other words, depending on the circumstances, an employee could choose when to pay income taxes.

3. Tax withholding

The employer will deduct taxes from the restricted stock units just like the regular salary and wage. Social Security and Medicare taxes are usually deducted at vesting, and taxes on income are deducted at delivery. Many companies will sell the shares without providing the option to do so to pay the tax withholding.

Some employers might let the employee pay by withholding taxes in different ways, such as with a personal check or deducted from the paycheck directly. Selecting the optimal withholding strategy depending on the unique circumstances is helpful. But more crucially, the employee needs to be aware of the amount of taxes, particularly income taxes, that the employer will deduct on the employee’s behalf.

A restricted stock unit is viewed as a supplementary source of income. Restricted stock units are sometimes subject to flat-rate federal income tax withholding of 22% (37% for amounts exceeding $1 million).

If the marginal federal income tax rate, excluding restricted stock units, is higher than 22%, the employee is probably not withholding enough. To avoid a potential penalty for underpaying estimated tax, the employee must either make quarterly estimated tax payments or increase the amount of withholding from each paycheck by revising the W-4. Some businesses withhold taxes from the restricted stock units at the same rate they do from the employee’s  W-4. If this is the case, the employee is less likely to have issues with estimated tax underpayment.

4. Trading restrictions

An employee can be subject to various trading limitations to prevent insider trading. The trading window and the blackout period are the two most popular ones. The employee is not permitted to trade in the company’s stock during the blackout period. On the other hand, the trading window is a window of time during which the employee is allowed to trade stocks.

Working for a business that recently went public may also subject you to a period of time known as the “lock-up period.” It generally lasts between 90 and 180 days from the IPO date. In other words, even if the restricted stock unit completely vests on the day of the IPO, the employee will be unable to sell them until the lock-up period ends shortly.

5. Dividends

Restricted stock units do not become real shares until they vest or are delivered; hence, they do not have voting or dividend rights. However, when paying dividends on actual outstanding shares of stock, certain companies may pay or accumulate dividend equivalents on restricted stock units.

Restricted stock unit holders will typically receive the accrued dividend equivalents at vesting in the form of cash or new shares. It is also important to check if the W-2 already includes any 1099-DIV the employee receives for those dividend equivalents. When submitting the tax returns, the employee should not include the same income more than once.

6. Beneficiary designations

A beneficiary designation is among the simplest ways to avoid probate. The employee can choose a beneficiary under some restricted stock unit plans, mainly if it accelerates vesting or permits vesting to continue. Beneficiary designations may not be expressly permitted or prohibited by some plans.

Final Thoughts

In the end, restricted stock unit plans are company-specific, just like other forms of stock compensation. Every plan may have a few unique features or clauses that are specific to it. Hence, employees must carefully study the plan agreement, ask questions about this to the HR department, or even consult outside consultants if necessary.

trica equity is a trusted partner of over 600 startups for stock options and cap table management. trica equity can help corporates looking to attract better, incentivize, and retain talent with state-of-the-art management software.