By AnnaMarie Mock, CFP®
Restricted Stock Units (RSUs) are a form of stock-based compensation that can potentially provide a windfall but may come with a sizable tax bill.
RSU Granting and Vesting Dates
RSUs have two important dates:
Grant Date: The Grant Date is when you are awarded the RSUs.
Vesting Date(s): The Vesting Date(s) is when you are transferred ownership of the shares and recognize the market value as ordinary income on your tax return.
83(b) Election
One way to minimize the potential tax bill on the vesting date is filing an 83(b) election within 30-days of when you initially receive the Grant. An 83(b) election allows an employee of awarded RSUs to be taxed on the equity award's value on the grant date rather than when it vests. As a result, this changes the shares' tax treatment to a more preferential capital gains rate rather than ordinary income rates.
The individual pays tax on the shares' market value when granted, so all future gains between the grant date and sale date will be considered long-term capital gains instead of ordinary income.
Example of Using an 83(b)
Let's take a look at Bob's situation. Bob is in the 32% federal tax bracket and is awarded 1,000 shares valued at $10 per share, making the value $10,000 on the grant date. The shares vest on a 4-year schedule, so Bob will have ownership of 250 shares every year. Bob will sell the shares as soon as they vest. What are the possible outcomes if Bob does or does not elect the 83(b) election?
With the 83(b) election, Bob elects to pay the ordinary income taxes on the shares upfront before the vesting period starts (needs to be elected within 30 days of the grant date). The current market value of $10,000 is included as taxable income and becomes Bob's new basis for the 1,000 shares.
1 Ordinary Income Rate, 32%; 2 Capital Gains Rate, 15%
In a scenario where the 83(b) election was elected, and the share price is below the grant price on the day of vesting, the individual overpaid in taxes for shares that are now worth less. Unfortunately, any overpayment of taxes under the 83(b) election will not be reimbursed and cannot be claimed as a tax loss on the tax return.
For example, in Year 1, 250 of Bob's shares vested at a $5 per share market price, $1,250 in value. Through the 83(b) election, Bob established his basis at $2,500 for the first tranche of vested shares (250 x $10), so there is no ordinary tax due. However, Bob is unable to take the $1,250 loss on his taxes. Since the vested stock proceeds declined over the 1-year vesting period, Bob would have been better off without the 83(b) election.
Nevertheless, the 83(b) election proves its value years 2 through 4 when the stock prices increase above the original grant price of $10 per share.
For example, in year 3, the price per share is $100 ($90 above the grant price). Because of the 83(b) election, Bob will not pay any ordinary income tax when the shares vest! If he sells them immediately, the gain of $27,500 (market value $30,000 less basis $2,500) will be treated as long-term capital gains at 15%, not ordinary income tax rates of 32%. If Bob did not make the 83(b) election, his tax bill would have been $4,625 more!
Over the 4-year vesting, Bob saved $13,000 in taxes by utilizing the 83(b) election.
The 83(b) election is most effective when the shares' value is projected to increase over the coming years. It is also optimal when the value of the shares at the time of granting is relatively low to avoid overpaying taxes if the stock price drops after the 83(b) election.
Typically, an 83(b) election would be disadvantageous if the employee chooses to leave the company voluntarily or was fired for cause before the vesting period ended. The taxes on the unvested shares are essentially prepaid with this strategy where the employee would never receive the unvested shares at termination. In some instances, the company may allow a terminated employee to retain all stock options.
If you are a pharmaceutical professional, dental profession, or newly independent woman and you have any questions regarding your stock awards or the 83(b) election, feel free to reach out to the HIGHLAND team.
Author’s Bio
AnnaMarie Mock is a CERTIFIED FINANCIAL PLANNER™ and Partner at HIGHLAND Financial Advisors, LLC, a Fee-Only financial planning firm that offers comprehensive financial planning, retirement planning, employer retirement planning, and investment management. AnnaMarie graduated from Montclair State University with a degree in finance and management and successfully passed the CFP® national exam in 2016. She has been working at Highland Financial Advisors since 2013 as a fee-only, fiduciary Wealth Advisor and is a member of NAPFA.