Congratulations, you have been awarded stock units by your employer! These awards come in a variety of flavors, but all represent the promise to transfer company stock (or a cash equivalent) to you at a later date or dates – the vesting date(s). If you are wondering how vesting works and how you will be taxed on your award, read on.
How Does Vesting Work?
Restricted Stock Units (RSUs) typically become payable to the employee (vest) over a period of time with the total award divided into increments that vest according to a schedule. Frequently, RSU awards are paid out in equal increments over 3-5 years. Alternatively, an award may be paid in full on the 1-year anniversary of the grant or be weighted so that a higher percentage is paid on the first or the last annual vesting date.
There is no standard vesting schedule, so be sure to check the official grant document provided by your employer for details on how your award will vest.
Performance Share Units (PSUs) tie the employee’s future payout of company shares to the achievement of some measurable goal. Typically PSUs specify a future date when performance toward the goal is evaluated. Shares may be paid out on this measurement date or the vesting date may be some other future date (such as the one-year anniversary of the measurement date). Less common are performance shares that vest on some indeterminate future date when the specified goal is eventually achieved.
There are several less-common types of stock unit awards that vest over time such as:
- Stock Appreciation Rights (SARs) in which the number of shares awarded at vesting is linked to the change in the company’s stock price during the period between the grant date and the vesting date.
- Total Shareholder Return Units (TSRUs) which award shares based on the change in stock price plus dividends declared during this same time period.
Remember that your company uses stock unit awards as an incentive to keep employees. If you leave employment prior to the vesting date, you will most likely forfeit the award. Some employers may offer limited exceptions for retiring employees.
How Are Stock Units Taxed?
Since a stock unit award doesn’t pay out unless a certain contingency is met – whether this is the passage of time or achievement of a performance goal – the award is not taxable upon receipt. Instead, the employee is taxed when the award vests and the shares (or cash equivalent) is received.
Since the award is considered compensation for services performed, the market value of the shares at vesting will be included on your W-2 and your employer will withhold payroll and income taxes. Most employers will retain some of the shares awarded to fund this payment of taxes and deposit the remaining shares in your account.
When you later sell your shares, you will have a capital gain or loss equal to the change in market price between the vesting date and the sales date. Shares held for one year or more will be subject to the historically more favorable capital gains tax rate.
Vesting and Taxation for Employee Stock Purchase Plans (ESOPs)
An ESOP is a form of qualified retirement plan in which your employer places company stock in a trust for your benefit. Vesting can occur gradually over a period of years (graded vesting) or all at once after a minimum number of years of service are met (cliff vesting).
Similar to other qualified retirement plans (think 401ks, etc.), your employer’s contribution to the ESOP is not taxable to you when it is deposited.
When you leave employment with a vested balance, the plan will distribute either actual shares of company stock or the cash equivalent to you.
This distribution may be in a lump sum or a series of annual payments. Because ESOPs are qualified plans, there are significant tax advantages.
- You have the option of rolling over your ESOP distribution(s) to an IRA or a new employer’s 401k. If you elect this option, the distribution is not currently taxable.
- Any cash payouts that are not rolled over are treated as ordinary income (and potentially subject to the 10% early withdrawal penalty if the recipient is under age 59-½).
- If actual shares of company stock are received, you will pay ordinary income tax only on the value of the shares at the time the company contributed them to the plan. You won’t pay tax on the appreciation in share value until you actually sell the shares at which time you will pay tax at the more favorable capital gains tax rate.
If you would like to learn more about vesting and how your stock units are taxed, please Contact Us to talk to one of our experienced advisors today.
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