If you are fortunate to work for a company that provides you with Restricted Stock Units (RSUs) or an Employee Stock Purchase Plan (ESPP), you may be sitting on a pile of company stock. In the early years, handling it may be straightforward: sell some and keep some. But as the value and number of shares grows, its no longer a simple decision. Should you sell some now and pay taxes or hold it?
RSUs have become increasingly popular with employers as a way to reward and retain valuable employees. Before RSUs, stock options were popular but they had some serious downsides: if the value of the options granted fell below the strike price, the option would be worthless. So much for rewarding employees!
RSUs act like a version of stock ownership, with significant restrictions. Your employer grants you a certain number of shares that track the value of the common stock. Over time the shares vest or, become available to be sold. Vesting typically occurs in increments such as 25% per year over a four-year period. Once vested, shares can be converted to the actual stock or sold at the then current stock price.
The RSU tax whammy
Because RSUs are considered compensation, they are subject to payroll taxes (e.g., FICA at 7.65%) plus regular state and local income taxes (for MA residents the tax can exceed 45% for high income earners). If you decide to hold your RSUs, you’ll still have to pay these taxes even though your take home pay has not increased. If you decide to sell your RSUs, you may also have to pay capital gains taxes on any gains. So, by the time you get done selling your RSUs, more than half the grant could go to taxes.
Because RSUs have different grant and vesting dates, you could end up with many different tax lots, some with big gains and others with small or no gains. Figuring out whether to hold or sell can be complicated by your company’s future prospects and stock price, and your tax bracket and need for cash.
Employee Stock Purchase Plans (ESPPs)
ESPPs are very different than RSUs. An ESPP uses your money to buy the stock of your employer at a discounted price. Assuming your employer is growing and successful, ESPPs can allow you to participate in the growth of your company. Most plans allow you to purchase your firm’s common stock at set times throughout the year via payroll deduction. Purchases are made at a discount from the market price of up to 15% and are usually limited to a specific dollar amount per year, such as $50,000.
Similar to RSUs, you’ll accumulate ESPP stock at different periods over time which will give you different tax lots, some can have large, unrealized gains and others could have small gains (or even losses) from your original purchase points.
Because you are using your own money to buy your company’s stock, payroll taxes do not apply. But you’ll need to be mindful of any accumulated gains because those will be subject to capital gains taxes. For most people, capital gains taxes are lower than ordinary income tax rates.
Problems to avoid
A problem that both RSUs and ESPPs share is single company concentration risk. In other words, you’re putting all of your eggs in one basket by participating. As you continue to accumulate shares, your concentration grows—along with your potential tax bill. In addition, if your company is not doing well, the stock price could fall causing the value of your RSUs and ESPP shares to decline in value. Over time, we’ve seen some employees accumulate enormous stakes in their employer stock. From an investment point of view, this increases your risk of loss, perhaps unknowingly.
Another issue that we see is behavioral. A number of folks that come to us with RSUs and ESPPs do not have a plan or strategy for reducing their single company risk, managing the tax associated with sales, and simultaneously meeting their need for cash. More often we see employees just selling some of what recently vested to pay off a car loan or provide a down payment on a home. This does not always result in the lowest tax result or lowered risk, especially with multiple goals and needs.
Before you embark on a big liquidation of RSUs or ESPP stock, give us a call. We can help you make a plan that avoids the big mistakes.
Lyman H. Jackson
Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. FPS provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client after entering into an advisory relationship. Information herein includes opinions and forward-looking statements that may not come to pass. Information is derived from sources believed to be reliable. Information is at a point in time and subject to change without notice. Such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.