7 Tax-Efficient Ways to Divest Your RSU Shares
By Josh Radman, in collaboration with MyStockOptions.com
Key Points
Understand your concentration risk and the activation barriers that may be making you reluctant to sell RSU shares and diversify out of your company's stock. Set up a predetermined, gradual selling plan.
You may want to sell RSU shares that qualify for long-term capital gains or have minimal appreciation. Consider selling up to the threshold of where the shares would push you into the next marginal tax bracket for ordinary income.
Other ideas involve collars, exchange funds, donor-advised funds, and gifts of appreciated stock.
With restricted stock units (RSUs), the easy part of accumulating newfound wealth is by vesting, which typically occurs dependably over months, quarters, or years so long as you remain employed by the company. The hard part is decumulating those shares, figuring out when to sell, and (importantly) doing so in a tax-efficient way.
The Question To Ask: Hold Or Sell?
The first piece of the puzzle is behavioral, more than anything: should you, the employee, keep your RSU shares in the hope that they go “to the moon” or should you sell them immediately upon vesting?
RSUs are taxed as ordinary income upon vesting—just as bonuses are taxed—so a good framework for employees to consider is this: If your company gave you a $10,000 cash bonus, would you take that money and repurchase your company shares on the open market?
Overwhelmingly, the answer that I hear most commonly from my clients is “no, I would not.” When framed in this way, few are so bullish that they would instinctively reinvest back into their employer. This response to the hypothetical question is actually a good proxy for what to do with your RSUs. If you wouldn’t re-buy your company’s shares on the open market with cash, you probably shouldn’t be holding onto your RSUs past vesting.
Remember, if you have additional RSUs vesting over the next few years, you have both explicit and implicit exposure to your company. Explicitly, you have shares that are tied to the company’s performance. Implicitly, you have both future unvested RSUs plus a job that is also dependent upon the company’s performance. If the company falls on hard times or misses estimates, then your shares, future RSUs, and your job could be at risk—a triple whammy!
Understand Your Concentration Risk
The somewhat official but more boring term for “triple whammy” is “concentration risk” (yawn). A good rule of thumb: if more than 10%–15% or so of your total wealth is tied up in your company stock (excluding the additional non-vested RSUs), you’re sitting on a nice pile of concentration risk. Statistically speaking, your best bet is to put together a diversification plan to take some chips off the table. Diversification, as they say, is “the only free lunch.”
Note: this is easier said than done, especially in a bull market. Even though most folks wouldn’t use a cash bonus to buy more company shares, many nevertheless think that their company stock can only keep going higher. “Our leadership team is solid; I completely trust them” or “our sales pipeline is really robust” or “we have the most talented engineers” are common rationalizations for employees to hold onto their RSUs long past vesting.
This is a great example of a (common) behavioral bias known as the endowment effect, wherein people intrinsically value things that they own more than the things that they don’t own and are therefore reluctant to dispose of such possessions.
Once you’ve overcome the mental hurdle of selling (great job!), how to do so in a tax-efficient way is the next daunting task. You have a few routes, outlined below.
1. Set Up A Predetermined, Gradual Selling Plan
This is the most straightforward, simple, and flexible way to make a move. And sometimes simplicity is a nice gift for your brain. The key is to make the selling plan mindlessly consistent. You don’t want to have to think about it. Make it automatic.
Regardless of whether you decide to sell a set number of shares each month/quarter/six months or sell a set dollar amount each month/quarter/six months, so long as your plan is consistent and requires minimal mental effort, you’re likely to succeed in your diversification strategy. Executives, however, should be aware that they may have company stock ownership guidelines which they must follow.
If you’re subject to trading blackout periods or occasionally possess material nonpublic information about your company, ask your financial advisor about setting up what’s commonly known as a 10b5-1 plan, which when properly created may let you avoid certain selling restrictions.
2. Sell RSU Shares That Qualify For Long-Term Capital Gains or Have Minimal Appreciation
In reviewing your RSU shares from each vesting tranche, you’ll notice that every share lot is likely to have a different cost basis (depending upon the price on vest date), potential capital gain (or loss), and holding period. Here’s how you might consider prioritizing which lots to sell first:
A. Sell Lots With Minimal Appreciation.
Assume that your RSU share – which vested at a price of $100 (your cost basis) – is still worth $100 18 months later. Upon sale of this RSU share, you will generate $100 of cash and $0 of tax upon sale. Selling RSU shares that have minimal appreciation is a great way to generate cash without significantly increasing your tax burden.
B. Sell Lots With Long-Term Capital Gains.
By selling RSU share lots that qualify for long-term capital gains treatment (held for more than one year after the vesting date), the gains on these shares will be taxed at a lower rate than the rates on short-term capital gains (which mirror ordinary income rates).
C. Sell Lots With Capital Losses.
If you’ve already recognized capital gains from the sale of other securities, you may consider selling RSU share lots that will generate a capital loss. Capital gains and losses are netted against each other every year, which may help to relieve your overall tax burden. The IRS also allows you to deduct $3,000 of unused capital losses against ordinary income, with any additional capital losses being carried over to the next tax year(s).
3. “Fill” Your Tax Bracket
The idea here involves selling a portion of your vested company shares that, presumably, you’ve been holding for more than one year so that they qualify for long-term capital gains tax treatment. You sell up to the threshold of where the shares would push you into the next marginal tax bracket for ordinary income. There can be both federal and state tax brackets, depending on where you reside. A hypothetical example:
You live in Florida (no state individual income tax or capital gains tax).
You’re a single filer and your taxable income is $200,000 per year, placing you in the 32% federal tax bracket for 2024.
If your taxable income in 2024 is above $243,725, your marginal tax rate is bumped up to 35%.
Therefore, you can recognize up to ($243,725 - $200,000) = $43,725 in additional capital gain sales from your company stock before getting bumped into a higher marginal tax bracket. While the long-term gains are taxed separately at 15%, they are also included in calculating your overall adjusted gross income (AGI) and therefore affect your tax bracket.
Recall that long-term capital gains are taxed more advantageously (0% - 20% at the federal level) than “short-term” capital gains (0% - 37% at the federal level). Therefore, you could optimize by selling shares that you’ve held for at least 1 year + 1 day (to qualify as long-term) and sell enough to where you generate $43,725 in long-term capital gains.
4. Use An Option “Collar” On Your Shares
Option collars can help lock in gains but come at the price of limiting your potential upside.
Alert: Your company may prohibit this form of hedging.
There are two parts to the collar:
Buying a “put” option on the stock that you own.
Buying a put is essentially the equivalent of buying insurance on your stock. Let’s assume that you own vested shares of Microsoft (MSFT). With a put option, if MSFT falls below a certain price, you have the right to sell your MSFT stock at that predetermined price. Put options, however, can be expensive to purchase, which is why they are often paired with selling call options.
Selling a “call” option on the stock.
Selling a call is the equivalent of capping the upside to your stock. In exchange for limiting your gains and giving someone else the right to buy your MSFT shares at a preset price, you get paid a premium. It’s this premium that is typically used to offset most (if not all) of the cost of buying the put.
Setting The Expiration Date Of The Option
If you’ve had a “big” year—that is, perhaps your company went public or you had numerous RSUs vest this year and are anticipating a higher-than-normal tax-bracket year—you’ll probably want to set your collar options to expire early next year.
In doing so, if your call option expires “in-the-money,” which requires you to sell your shares, you are able to do so in the next calendar year, thereby recognizing capital gains in a lower-tax-bracket year.
5. Consider Using An Exchange Fund For Company Stock
The idea behind an exchange fund is that investors who have concentrated positions of individual stocks all pool their shares together without incurring any taxable sale. Investors with holdings in various companies then share in the risk and performance of the diversified portfolio and defer capital gains until withdrawal, thereby reducing an individual investor’s concentration risk and immediate tax recognition. The devil, however, is in the details. Exchange funds:
Tend to take a hefty annual fee (0.50% - 0.95%; it adds up!)
Are fairly illiquid and require extended lockup periods (I’m talking a 7+ year lockup)
Are typically available only for Qualified Purchasers (with a few exceptions for Accredited Investors), and
Typically make sense only if you have low-cost-basis shares and sizeable unrealized gains (meaning you should definitely run the numbers).
With exchange funds, you’re also only deferring capital gains—not eliminating them—so the hypothetical savings may actually not make all that much sense.
6. Contribute To A Donor-Advised Fund
Feeling charitably inclined? Most charities and nonprofits will gladly accept stock donations. If you are not certain right now about which charities to give to, I have great news: by contributing highly appreciated stock to a donor-advised fund (DAF), both you and the charities of your choice win. Here’s why:
You can contribute shares to a DAF without selling them, thereby avoiding any significant capital gains tax. As the DAF is a tax-exempt organization, it doesn’t pay capital gains on the stock sale.
You get to deduct the fair market value of the donated shares from your taxable income.
When you select which organizations receive your DAF grants, each charity receives the entire value of those donated shares.
How’s that for a win-win? Do well by doing good! You can contribute even if you aren’t yet sure to which charity you want to donate. There are many relatively low-cost DAFs available, so the idea is worth discussing with your financial advisor.
7. Gift Appreciated Stock
In 2024, you may gift up to $18,000 ($19,000 in 2025) to any individual without triggering gift tax or reporting requirements to the IRS (via Form 709). Have relatives or good friends to whom you want to gift $18,000 each? Lucky them, and not a problem. You don’t have to gift cold, hard cash. Instead, you can gift $18,000 worth of RSU shares to each of them via direct transfer to and from most brokerage accounts. While you won’t be able to take a tax deduction against these gifts, you will nevertheless be able diversify out of appreciated shares without recognizing any additional taxable income.
Two considerations worth noting:
If the fair market value of the RSU shares is greater than their cost basis on date of gift: The recipient of the gifted RSU shares will take your (donor’s) cost basis and initial holding period date.
If the fair market value of the RSU shares is less than their cost basis on the date of gift: don’t gift these shares! Instead, sell the shares, recognize the capital loss, and then gift the cash in a separate transaction.
This article was published in collaboration with MyStockOptions.com.