RSUs and Your Company’s IPO: Taxes and Other Considerations
Congratulations: your RSUs are about to fully vest! RSUs issued by a private company are sometimes called “double-trigger RSUs.” You must meet two criteria for your RSUs to fully vest: (1) you have to work for a certain period of time (e.g., 25% of your RSU grant vests every 12 months), and (2) your company must have a liquidity event (e.g., IPO).
What to Expect at IPO
Let’s say you were granted 10,000 RSUs when you started your job on January 1, 2021. And your company goes public on January 1, 2022. Assuming 25% of the grant vests after one year, you may be thinking that you can sell 2,500 shares on January 1, 2022; however, when you log into your equity plan’s website, you’ll see 0 shares available for sale. There are two reasons for this:
Lock-up period. There is a waiting period after the IPO that forbids employees and other company insiders from selling shares. The lock-up period traditionally lasted six months. But I’m seeing companies offering a narrow window of time for employees to sell some shares before the lockup comes off. Other companies are forgoing traditional IPOs altogether with direct listings or SPAC mergers.
Income taxes. When the lock-up expires, income taxes will reduce the number of shares you receive. When the 2,500 RSUs fully vest on January 1, 2022, you must pay taxes despite the lock-up period. Vesting of RSUs is considered income to the IRS (and your state, if applicable). Even if you end up holding onto the shares acquired from the RSU vesting, you can’t avoid income taxes.
You pay the income taxes in two pieces:
- You pay on the vesting date (e.g., January 1, 2022). Like bonuses and commissions, vested RSUs are considered “supplemental wages”. Supplemental wages are taxed based on a series of flat rates as defined the IRS and your state tax authority. For example, IRS law mandates that 22% of supplemental wages be withheld to cover federal income tax liability. And in California, it’s 10.23% for state income tax. Most companies will sell shares on your behalf to cover the mandatory taxes withheld at vest. They can sell these shares despite the lock-up period.
- For high earners, the mandatory withholding may be insufficient. You square up what you owe either through estimated tax payments, or next April 15th when you file your tax returns. Consult with a financial planner or tax professional to ascertain which applies to you.
Let’s assume the lock-up period expires July 1, 2022. When you log into your equity plan’s website on this date, rather than receiving 2,500 shares, let’s say you receive 1,450 shares after withholding taxes.
Decide What To Do With Your Company Stock
Your next steps are to decide what to do with the ~1,450 after-tax shares, and shares resulting from future RSU vesting. The first step is to determine whether you will owe additional taxes next April 15th. If you don’t have enough cash on hand to pay, consider selling a portion of the ~1,450 shares to cover the tax bill.
Once taxes are covered, here are the top two comments that I hear from clients and prospects:
I want to keep my shares because I believe in my company’s prospects. Some people might be able to keep their company stock because they can afford the risk. For example, if a person wants to work forever, she can attain their financial goals even if their company stock price dropped by a large percentage. However, I reframe the issue as follows: “If your company paid $200,000 cash bonus [the assumed pre-tax value of vested RSUs], would you use this money to purchase company stock?” Most clients quickly answer, “No, I’d keep the cash.” If you answered “No,” then you should think of the RSU payment as a bonus that happened to be paid in shares rather than cash. In other words, sell all the shares immediately; your company will withhold taxes, and you keep the remaining cash.
I want to keep my shares for at least one year to “save on taxes”. It’s true that when you hold a capital asset for more than one year, long-term capital gains are taxed at a special, lower rate. Short-term capital gains are taxed at regular income tax rates, which are higher. But remember that there are two sets of taxes for RSUs:
- You pay taxes on the value of the RSUs at vesting (income taxes).
- You pay taxes again when you sell the shares resulting from the vested RSUs (capital gains taxes).
Clients often focus on capital gains taxes. Don’t forget the first set: you’ve already paid federal and state income taxes based on the stock’s value at vesting. And you may owe a balance on your income taxes next April 15th. Consult with a tax professional or financial planner to determine how much, if applicable. You can sell enough shares to cover additional taxes owed.
Next, let your goals determine whether to sell some or all the remaining company stock. A financial planner can provide context by helping you articulate your goals, and running a long-term financial projection to compare:
- What you want to achieve (start your own company, downshift to a less stressful job, buy a house, pay for college, etc), and
- What you have (e.g., your current and future savings)
For most of my clients, the long-term projection shows that they can achieve their goals if they sell all the shares and reinvest in a diversified portfolio. In the words of William Bernstein, “If you’ve won the game, stop playing.”
I wrote a longer blog post on what to do with company stock.
Trading Your Company Stock After Lock-up Expires
Blackout periods. Once the lock-up period ends, you may continue to face restrictions on selling company stock. Many companies, including Facebook and Lyft, forbid all employees from buying or selling company stock during “blackout periods.” Other companies, including Microsoft and Cisco, don’t have blackout periods.
Trading windows. You can buy or sell company stock during a “trading window”, specific windows of time after your company’s quarterly earnings release. This is to prevent insider trading, which is a violation of federal securities law. Your company’s HR or legal department will announce when trading windows are open. The length of the window varies by company, but I’ve observed 10-30 days per window.