5 Tax Saving Strategies for RSUs

Introduction

Restricted Stock Units (RSUs) have become an increasingly popular form of equity compensation, especially in the tech and startup world. While RSUs can be a valuable part of your compensation package, they also come with complex tax implications that can take a significant bite out of your earnings if not managed strategically.

This article covers general tips about optimizing RSU tax strategies to reduce liabilities and increase retained earnings:

• How RSUs are taxed and what you need to know.
• Five strategies to reduce your RSU tax burden.
• Pro tips for aligning RSUs with your financial goals.

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Understanding RSU Taxation: The Basics

Before diving into specific strategies, it's crucial to understand how RSUs are taxed. When your RSUs vest, the fair market value of the shares becomes taxable as ordinary income, even if you don't sell the shares immediately. This means you'll pay federal income tax, state income tax (where applicable), Social Security, and Medicare taxes on the value of your shares at vesting.

This "double taxation" scenario - paying income tax at vesting and potentially capital gains tax when you sell - makes tax planning for RSUs particularly important.

Strategy 1: Strategic Timing of Share Sales

One of the most powerful ways to manage RSU tax impact is through careful timing of your share sales. This strategy involves making deliberate decisions about when to sell your vested shares based on both market conditions and your tax situation.

When your RSUs vest, you have two main options: sell immediately (often called "sell-to-cover") or hold the shares for potential future appreciation. If you choose to hold, any subsequent gains or losses will be treated as capital gains or losses when you eventually sell.

For example, if your RSUs vest when your company's stock price is $100 per share, you'll pay ordinary income tax on that amount regardless of what you do next. If you hold the shares and they appreciate to $150 before selling, you'll pay capital gains tax on the $50 increase.

The key is to align these decisions with your broader tax situation. If you expect to be in a lower tax bracket in the future, holding shares and selling them later might result in lower overall taxes. Conversely, if you're concerned about concentration risk or believe your company's stock might decline, selling immediately might be the better choice despite the tax implications.

Strategy 2: Tax-Loss Harvesting with Other Investments

While you can't avoid the initial income tax hit when RSUs vest, you can potentially offset capital gains from RSU sales through tax-loss harvesting with other investments in your portfolio.

This strategy involves strategically selling investments that have declined in value to realize losses that can offset capital gains from your RSU sales. The key is to maintain your desired investment exposure while capturing tax benefits.

For instance, if you have RSU shares with substantial gains and other investments showing losses, you might sell both to net out the tax impact. Just be sure to avoid wash sale rules by not repurchasing substantially identical securities within 30 days before or after the sale.
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Sample Situation: Emily is an employee at a tech company. Her RSUs vested last year, and their FMV was $50,000 (200 shares at $250 per share). She sold the shares immediately and paid ordinary income tax on the $50,000. Since then, the stock has appreciated, but she also owns an underperforming mutual fund.

Action:

• Emily decides to sell the underperforming mutual fund, realizing a $10,000 capital loss. She then offsets this loss against the $15,000 capital gain she earned by selling RSUs she held for a year.
• This strategy reduces her taxable capital gain from $15,000 to $5,000, significantly lowering her tax liability.

Outcome: Emily successfully reduces her overall tax burden by leveraging losses from other investments while maintaining her desired portfolio balance.

Strategy 3: Multi-Year Income Planning

RSU vesting schedules often create income spikes that can push you into higher tax brackets. Multi-year income planning involves looking at your vesting schedule alongside your other income sources to minimize the overall tax impact across multiple years.

This might involve:

• Working with your employer to adjust vesting schedules when possible
• Planning other income-generating activities around your vesting dates
• Making strategic charitable contributions in high-income years
• Maximizing retirement account contributions during vesting years

For example, if you know you have a large RSU vest coming up next year, you might accelerate some deductions into that year or defer other income into the following year to help smooth out your tax liability.

Strategy 4: Utilizing Qualified Retirement Accounts

While you can't directly roll RSUs into retirement accounts, you can use retirement account contributions strategically in years when you have significant RSU income. This approach helps offset the tax impact of vesting events.

Consider maximizing contributions to:

• Traditional 401(k) plans
• Health Savings Accounts (HSAs)
• Traditional IRAs (subject to income limitations)

For instance, if you have $50,000 in RSUs vesting, making the maximum possible contribution to your 401(k) that year could help reduce your taxable income and potentially keep you in a lower tax bracket.

Strategy 5: Charitable Giving Strategies

For those charitably inclined, strategic giving can be an effective way to manage the tax impact of RSUs. This is particularly valuable if you've held RSU shares that have appreciated significantly after vesting.

One powerful approach is donating appreciated shares directly to charity rather than selling them and donating cash. This provides a double tax benefit: you get a charitable deduction for the full market value of the shares, and you avoid paying capital gains tax on the appreciation.

For larger charitable goals, consider establishing a Donor-Advised Fund (DAF). This allows you to contribute appreciated RSU shares, take an immediate tax deduction, and then distribute the funds to charities over time according to your preferences.
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Sample Situation: John, a senior software engineer, has RSUs that vested at $75,000 two years ago. He held onto the shares, and they are now worth $100,000. John is charitably inclined and wants to support a nonprofit.

Action:

• Instead of selling his RSUs and donating cash, John donates the appreciated RSUs directly to the nonprofit.
• By doing so, he avoids paying capital gains tax on the $25,000 appreciation. Additionally, he receives a charitable deduction for the full $100,000 market value of the shares.

Outcome:John maximizes his charitable impact and reduces his taxable income while avoiding additional capital gains taxes.

Implementation Considerations

When implementing these strategies, several factors deserve careful consideration:

Timing and Market Conditions

While tax optimization is important, it shouldn't be the only factor in your RSU decisions. Consider:

• Your company's current valuation and future prospects
• Overall market conditions
• Your personal financial goals and risk tolerance
• Portfolio diversification needs

Coordination with Other Financial Planning

RSU tax planning should be integrated with your broader financial strategy, including:

• Emergency fund maintenance
• Retirement planning
• College savings
• Estate planning
• Risk management

Professional Guidance

Given the complexity of RSU taxation and the interaction with other aspects of your financial life, working with qualified tax and financial professionals can be valuable. They can help you:

• Model different scenarios
• Understand tax implications
• Coordinate various strategies
• Stay compliant with relevant regulations

Frequently Asked Questions

about RSU Tax Strategies

What are RSUs, and how are they different from stock options?

Restricted Stock Units (RSUs) are a form of equity compensation granted to employees, which represent company shares that are issued upon vesting. Unlike stock options, which give employees the right to purchase shares at a set price, RSUs are delivered to you outright as shares once they vest. This makes RSUs less speculative but also tied directly to the company’s stock price at the time of vesting.
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How are RSUs taxed when they vest?

When RSUs vest, their fair market value (FMV) is treated as ordinary income and taxed accordingly. This includes federal, state, Social Security, and Medicare taxes. The FMV of the shares is based on the stock price at the time of vesting, and you’ll be responsible for taxes even if you don’t sell the shares immediately.

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What is the difference between income tax and capital gains tax on RSUs?

Income tax applies to RSUs at vesting, based on the FMV of the shares, and is taxed as ordinary income. Capital gains tax applies when you sell the shares. The difference between the selling price and the value at vesting determines the capital gain or loss. If you sell within a year, it’s a short-term capital gain (taxed at higher rates); if you hold for over a year, it’s a long-term capital gain (taxed at lower rates).

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What is a "sell-to-cover" strategy, and when should I use it?

A "sell-to-cover" strategy involves selling a portion of your RSUs immediately upon vesting to cover the tax liability. This is a common approach to avoid paying taxes out of pocket, especially if you prefer to hold the remaining shares for potential future appreciation. Use this strategy when you want to minimize your tax burden at vesting while still retaining some exposure to your company’s stock.

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How can tax-loss harvesting help offset the tax burden from RSUs?

Tax-loss harvesting involves selling investments in your portfolio that have decreased in value to realize a loss. This loss can then be used to offset capital gains from the sale of your RSUs. For example, if your RSU shares generate a capital gain, selling underperforming investments can reduce your overall taxable gains, effectively lowering your tax liability.

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Can I change the vesting schedule for my RSUs to reduce taxes?

In most cases, RSU vesting schedules are set by your employer and cannot be altered. However, some companies offer flexibility in deferred compensation programs, or you may be able to negotiate vesting terms during your initial offer. If your vesting creates significant income spikes, consider working with a tax professional to plan for deductions or other strategies to mitigate tax impacts.

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What are the benefits of donating RSU shares to a charity?

Donating RSU shares, particularly those that have appreciated in value, can provide a double tax benefit. First, you avoid paying capital gains tax on the appreciation. Second, you can claim a charitable deduction for the full market value of the donated shares. This is an excellent strategy for individuals who are charitably inclined and want to reduce their overall tax burden.

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Do I need a financial advisor to plan my RSU tax strategy?

While not mandatory, working with a financial advisor can be incredibly valuable. RSU taxation involves complex rules and significant financial implications, especially when combined with other aspects of your financial plan. A financial advisor can help you navigate tax strategies, align RSUs with your overall financial goals, and ensure you maximize the value of your equity compensation.