Companies have added several components to their employee compensation packages and schemes. One of the many popular ways of offering employees benefits is in the form of restricted stock units.
Restricted Stock Units or RSUs are a type of stock compensation where the shares are taxed as capital gains once vested in the employees. The RSU stocks can be of great benefit to employees and can sometimes account for 50% of their annual package when used the right way. The RSU tax plays a major role in maximizing profits once the RSU stocks are vested.
Having knowledge of the RSU tax and proactively managing it can help employees increase their returns.
This article will help employees understand RSUs and their taxation to reap the maximum benefits.
How are Restricted Stock Units Taxed?
RSUs are “restricted” to certain conditions laid by the employer. Employees cannot sell them until they have met the vesting requirements, which normally occurs after a specific number of months or years.
Once they are vested, RSUs are subject to income tax at the standard rate. Capital gains tax only if there has been an increase in the price of the stock that has resulted in a profit since the stock was issued to the employee.
4 Strategies to Lower Taxes on RSUs
The profit or the amount of value raised through appreciation is subject to capital gains tax. Taxes imposed on RSUs cannot be completely canceled. But with an efficient taxing strategy, employees can lower their taxable amount. Here are some strategies to help lower tax implications on RSUs.
1. Maximizing Tax-Deferred Contributions with RSUs
RSUs are taxed only if the vested stocks have made a profit since the day it was vested. Employees can have a tax benefit by lowering the taxable income for the current year by making contributions to the employer-sponsored 401(k) or Individual Retirement Account (IRA).
The profits from selling the RSUs can be used to fund all tax-deferred accounts. Tax deferred accounts enable the employer to postpone the tax liability if the RSUs are held to postpone paying taxes on gains. Moreover, it helps diversify the portfolio.
2. Deduction Bunching
Deduction bunching becomes crucial for anyone wishing to itemize deductions as part of their tax returns as a result of the 2017 Tax Cuts and Jobs Act‘s rise in the standard deduction to $25,900 for couples and $12,950 for individuals.
Deduction bunching is essentially packing as many deductions into one tax year to increase itemized deductions over the standard deduction, which ultimately reduces taxes for that year.
If there is a sizable amount of RSUs vesting in any given year, bunching deductions can offset some of this income because RSUs are taxed as income in the year they vest.
Some top itemized deductions are mortgage interest, donations to charities, medical costs, real estate taxes, and state and local taxes.
3. Donor Advised Funds
Based on this strategy, a charitable organization or fund is created under the name of the employee. All the contributions to the fund are tax-deductible in the year of the contribution. The assets which are invested through the fund can grow without tax implications.
A DAF can be funded from a stock yielding high profits. Donors can hence avoid capital gains tax on the donated stocks while still receiving a tax benefit for the funding year.
4. Hedging to Defer Taxes
Hedging RSU positions and delaying the sale is a strategy to hold stocks for longer or to postpone the tax bill to a possibly more advantageous year.
Restricted Stock Units are a straightforward way of stock compensation and have a simple taxing process. They also retain value and can be a great way to offer cash bonuses to employees when they are managed efficiently.