Is there a tax advantage to holding my RSUs past vest?
I get this question a lot. Skipping right to the answer: no, there is not.
In fact, one of the most common mistakes that I see people make is to hold their RSUs past vest because they think there is a “tax efficiency” to be gained. This is false and simply a confusion between how ordinary income and capital gains taxation works. Don’t make this mistake.
Here’s the situation that probably sounds familiar: You’re an employee at a public company and, as part of your compensation package, you have RSUs that vest consistently each quarter or month (assuming you’ve met your “cliff”).
You can think of these RSUs just like a cash bonus that you earn consistently over time.
What happens when you get a cash bonus? You are taxed immediately, and your company withholds a certain percentage to cover income tax, social security tax, and Medicare tax (the latter two are known as “FICA” taxes).
Let’s use some numbers:
Cash bonus amount: $100,000
Cash bonus is distributed to you on April 1 of Year 1
Company withholding rate is 30% (22% for federal taxes + 8% for state taxes)
This means that your company will withhold $30,000 (30% of $100,000) before your bonus is even distributed to you.
Therefore, on April 1 of Year 1 you will see $70,000 of cash deposited into your account.
Most people don’t realize that RSUs are taxed identically to a cash bonus.
Let’s use some numbers, again:
RSU amount: 10,000 shares at $10 each ($100,000 worth)
RSU vests on April 1 of Year 1
Company withholding rate is 30% (22% for federal taxes + 8% for state taxes)
This means that your company will withhold $30,000 (30% of $100,000) before your RSUs are even distributed to you.
In practice, your company will typically sell 3,000 shares at $10 each ($30,000) to cover that 30% withholding (known as “sell-to-cover”)
Therefore, on April 1 of Year 1, you will see $70,000 of RSU shares deposited in your account.
The numbers are identical. With both the cash bonus and the RSU shares, you end up with the exact same amount: $70,000 post-tax.
If, on April 1 of Year 1, if you were to sell your remaining 7,000 RSU shares immediately upon vest at $10 per share, you would similarly generate $70,000 in cash.
How much of that $70,000 cash is taxable?
Here’s where people get confused: none ($0) of the proceeds on the $70,000 of vested RSU shares are taxable.
You already paid taxes on your RSUs when they vested! Now, you’re left with $70,000 worth of shares, which becomes your “basis”. Basis is a good thing – the more basis you have, the less gain you have. The less gain you have, the less tax you owe.
If your basis hasn’t changed because the price at which you’re selling it hasn’t changed, then there is nothing to be taxed.
Let’s look at this with the cash bonus example (taxed identically to RSUs): If, hypothetically, you “sold” $70,000 of cash for $70,000 of cash, how much of that is taxable? $0, obviously. It makes no sense that selling something for the exact same amount would be taxable.
The same is true for your RSU shares.
So should I sell my RSUs upon vest or hold them?
The data – no matter how you slice and dice it – will show that it almost always makes sense to sell your RSUs upon vest and reinvest those proceeds into a broadly diversified portfolio. This is because the vast majority of stocks underperform the market (significantly) over the long run. It’s only a very select few companies that generate gargantuan returns which, in turn, lift the averages for all.
And don’t be fooled into thinking that just because a company generates a higher return that it was worth it. You also need to consider this from a risk-adjusted perspective. In other words, if your asset generated higher returns, but you took a helluva lot greater risk to generate those returns, it might not have been worth it.
If you do think you can pick stocks that consistently overperform over extended periods of time, then I’d encourage you to drop everything and go lead a hedge fund on Wall Street.
But I digress. See my blog post on the data behind why you should sell upon vest for more details.
What happens if you hold onto your RSU shares past vest date?
On April 1 of Year 1, you had $100,000 of RSU shares vest and, post-tax, had $70,000 of RSU shares (7,000 shares x $10/share) show up in your account.
You decided not to sell your RSU shares.
Fast forward to October 1 of Year 1: your company has done well! Woo! The stock price is now trading at $15/share and your account value has grown to $105,000.
If you decided to sell your RSU shares at this point (October 1), what is your taxable gain?
Recall that your basis is 7,000 shares x $10/share = $70,000. This money will not be taxed again. Now you have $105,000 - $70,000 = $35,000 in “capital gains”. This $35,000 amount will be subject to capital gains tax, and the rates vary depending upon how long it has been since the RSU shares vested (your “holding period”).
What if we had sold the RSU shares when they were worth $10 and reinvested that money into a broadly diversified portfolio that was now worth $105,000? Identical situation; also subject to the exact same capital gains tax.
For this reason, there’s no tax benefit to holding RSUs past vest.
What’s a good framework for thinking about whether to hold or sell my RSUs?
Statistically, you’re more likely to make more money by selling your RSUs upon vest (remember, if the price hasn’t changed then there is no realized tax) and reinvesting those proceeds into a diversified portfolio of stocks.
But if you’re wanting to hold your RSUs past vest, here is the question that you should ask yourself:
“If your company gave you a $100,000 cash bonus, would you use those proceeds to go re-buy your company stock on the open market?”
Most people answer this with “no, I wouldn’t go re-buy my company stock”. And, if that is also your answer, then you’ve answered your own question. If you’re not willing to re-buy your own company’s shares, then you should not be willing to hold onto the RSU shares past vest – because it’s an identical situation.
If, however, you would go buy more of your company’s shares on the open market then there’s an argument to be made that you could hold your shares past vest. But you should also be considering your concentration risk, and a few other factors.
Helping folks understand more about their equity compensation, stock options, RSUs, and taxes is my bread and butter. Feel free to reach out if you have more questions around how to strategize with your RSUs.