What is a Restricted Stock Unit?

PSA – despite their similar names, RSUs are not restricted stock awards (RSAs)!

In contrast to RSAs, RSUs are a contractual promise by a company to transfer stock (or the cash equivalent) to a service provider at a specific time in the future. So unlike with an RSA, an RSU recipient is not paying for and getting shares at the time of grant, meaning the RSU recipient is not a beneficial owner of the shares and not entitled to vote, sell, get dividends, etc.

As with other equity compensation, RSUs are often subject to vesting and settled (ie. the underlying stock is issued or the cash-equivalent is paid) upon vesting, although RSUs can be structured with deferral features so that recipients may time certain tax liabilities.

When dealing with taxing RSU, there are 4 phases to consider with taxes – at the time of grant, vesting, exercise, and sale of the underlying stock.

1. At grant, an RSU is not taxed.

2. At vesting, an RSU is also not taxed, but the fair market value (FMV) at the time of vesting is subject to Federal Insurance Contributions Act (FICA) taxes, which will be deducted from recipient’s payroll.

3. At exercise, an RSU is taxed as ordinary income equal to the FMV of the stock (or cash) issued at settlement.

4. At sale (if applicable), with the stock underlying the RSU that is sold the recipient realizes capital gains/losses on the difference between the sale proceeds and the stock's FMV at the time of sale.

At first glance, RSUs may seem great for recipients because they do not need to pay for their stock.

However, RSUs are typically reserved for late-stage/mature private companies (and often only those that are on the verge of a liquidity event such as an IPO or tender offer in which RSU recipients can sell their stock to pay their tax bills) because (i) the underlying stock typically needs to have a high-enough valuation to make the RSU worthwhile for the recipient and (ii) they carry significantly more tax liability and administrative requirements such as payroll tax withholdings than other forms of compensation. If anything, RSUs are more likely reserved for certain senior executives who are potentially better able to afford the tax liabilities. As a result, even late-stage/mature private companies often stick with options and RSAs as the standard equity compensation.