Once upon a time, stock options were the only show in town when it came to incentivizing employees, but in recent years the restricted stock has emerged as an increasingly popular form of equity compensation. This trend has become noticeable in both established companies and startups.
Restricted stock comes in two varieties: Restricted Stock Awards (RSAs) and Restricted Stock Units (RSUs). In this ‘’RSA vs RSU’’ article, you‘ll learn:
- What is a restricted stock award (RSA)?
- What is a restricted stock unit (RSU)?
- RSA tax treatment VS RSU tax treatment
- RSA at termination VS RSU at termination
- FAQs
First, let’s quickly review the main differences between these two restricted stock types.
Difference between RSA and RSU
An RSA is a grant of company stock, offering employees the right to purchase at a discount, or at no cost on the grant date (i.e. own shares at grant). An RSU is a promise to give employees shares at a future date at no cost (i.e. not own shares at grant).
| RSA | RSU |
|---|---|
| Company shares issued at grant | Company shares not issued until vesting |
| Voting rights gained at grant | No voting rights until vesting |
| Employee may need to pay for the grant | Employee not required to pay for the grant |
| Build wealth by ‘’buy low sell high’’ | Build wealth by selling shares acquired with no cost |
| Eligible for Section 83b election: Helps avoid ordinary income tax |
Not eligible for Section 83b election: Ordinary income tax necessary |
| Unvested shares can be purchased back from employees at termination | Unvested shares will be forfeited at termination |
| Common in Startups | Common in established companies (Private & Public) |
What is a restricted stock award (RSA)?
An RSA is a grant of company stock awarded to employees as part of their compensation package when they join the company and they immediately become a stockholder with voting rights. But, they can’t sell them until they vest (or become available to sell).
How does an RSA work?
At the time of an RSA grant, you may be required to pay your employer a purchase price for the grant if you accept it. It’s usually below the stock’s current or potential value.
After providing the payment (if applicable), you must wait until the grant vests. RSA vesting here is the process of earning the grant over time, usually linked to a time-based clause and/or a liquidation event, such as an IPO or sale of the company. So, it means although you have been awarded the equity on day one, you don’t have the right to the RSA until the condition has been satisfied.
When the grant vests, you’ll receive the shares of company stock or the cash equivalent (depending on your company’s plan rules) without restriction. The definition of stock vesting can be found in our vesting guide.
RSA for Startups
Typically, with a startup, early employees will receive RSAs prior to the first round of equity funding, when the FMV of common stock is very low. If employees are offered RSAs linked to the FMV of common shares on the grant date, one of the attractions for the employees is that if the business succeeds, the value will increase over time.
It means that their shares will be worth more than they paid for them – possibly substantially more – when they vest. All in all, this can prove highly effective in incentivizing startup employees.
Owners of startup may not have a lot cash to pay for salaries and consider RSA as a part of employee’s compensation package. If you want to know more about RSAs for your company, contact us today!
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What are restricted stock units (RSUs)?
Restricted stock units (RSUs) are a grant valued in terms of company stock, offered by an employer to employees as a form of compensation without employees having to buy them. Most companies create vesting schedules for RSUs to encourage employee retention.
It is quite similar to an RSA by definition but you’ll see some obvious differences in ‘’how it works’’.
How do RSUs work?
At the time of an RSU grant, you don’t have to pay anything and there is no company stock issued (unlike an RSA that you may need to pay for the shares and receive shares at grant). Instead, you’re promised to receive the shares of company stock or the cash equivalent (depending on your company’s plan rules) in the future after all RSU vesting requirements have been met.
When you meet these restrictions (e.g. time-based clause), which should be outlined in your RSU grant, your RSUs vest and you receive your shares. It means you can sell them as well.
RSUs for established private companies and public companies
Whereas RSAs can be a logical choice for startups, RSUs make more sense for established companies where their share price might be riding high, and there may be limited scope for further upward movement (and the ever-present risk of a downward spike). Examples are Microsoft, Amazon, Intel and Google. So, there is little incentive for your employees to accept RSAs.
No matter a private or public company, the operations are the same – employees need to wait until their RSUs vest and will pay taxes when the RSUs vest. But there is a thing about RSU vesting for private companies everyone needs to know about. Read on.
RSU vesting in private companies
Problem: If your RSUs vest when your company is still private, you’ll owe taxes but NOT be able to sell the shares for the money because your company is private which stock is difficult to trade on public markets.
That’s risky because you need to pay your tax bill out of your pocket for the stock that may or may not be worth something in the future.
Solutions: Thankfully, there is a mechanism called ‘’Double-Trigger Vesting’’. As the name suggests, you will need to meet two requirements before the shares are truly yours – 1) the vesting date arrives, 2) The company goes public.
The mechanism is used by many private companies with this situation to help employees address the problem that there is no market to sell the shares at vesting where they need to put their existing money to pay income tax.
Want to know more about ‘’Double Trigger Vesting’’ or generally restricted stock? Contact us today. Our experts will give you professional advice for your company to save you time during research.
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How are RSAs taxed?
i) Under normal federal income tax rules
For RSAs, you are not taxed at the time of the grant until vesting under the normal federal income tax rules.
At the time of vesting, the tax liability will be assessed based on the difference between the FMV at vesting and the price that was paid at the time of the grant.
- Employee’s cost at grant: $1/share
- FMV at vesting: $5/share
Taxable gains = $5 – $1 = $4 (Subject to ordinary income tax)
If this employee goes on to sell those shares for a profit, then that profit will be liable for capital gains tax (the difference between the sale price and the price at vesting).
- FMV at sale: $15/share
Taxable profits = $15 – $5 = $10 (Subject to capital gains tax)
BUT, the main potential pitfall here is: What if you can’t sell your shares at vesting (e.g. due to no liquidity) or the shares drop after vesting!?
Once the taxes due on RSAs are paid, no refunds will be forthcoming, irrespective of what subsequently happens to the share price.
The good news is that there is a way around this issue – the 83(b) election.
ii) Under section 83(b) election rules
Under 83(b), you can choose to pay all your ordinary income tax upfront. That might not sound great at first glance, but it can make a big difference.
The key to why this works is that the taxable gain will usually be $0 (regardless of the FMV at vesting). The taxable gain here is the difference between what an employee pays for the shares at the time of the grant and the FMV of the shares at that time.
We’re going to explain the taxes on RSA under 83(b) using the same figures:
- Employee’s cost at grant: $1/share
- FMV at grant: $1/share
- FMV at vesting: $5/share
Taxable gains = $1 – $1 = $0 (Subject to ordinary income tax)
- Employee’s cost at grant: $0.5/share
- FMV at grant: $1/share
- FMV at vesting: $5/share
Taxable gains = $1 – $0.5 = $0.5 (Subject to ordinary income tax)
So under 83(b), you are not subject to further tax until the shares are sold.
For the capital gains tax (CGT), Sticking with the numbers we have been using, if the employee then goes on to sell the shares at $15, the CGT liability will be assessed on the difference between the FMV at grant and the sale price (as opposed to FMV at vesting).
- FMV at sale: $15/share
Taxable profits = $15 – $1 = $14 (Subject to capital gains tax)
Since the CGT rate will be much lower than the level set for ordinary income tax, the ultimate bill will be far less than if you proceed without making an 83(b) election. And you also pre-empt the possibility of paying taxes on illiquid shares that cannot be sold.
How are RSUs taxed?
Remember, RSAs grant shares to the recipient at the outset, whereas RSUs are a promise that the company will award shares to the employee. The practical effect of that distinction causes quite different RSU tax implications from RSA’s – an RSU holder is usually liable for a bigger income tax bill at vesting.
An employee faces no tax bill when the RSU is granted but will be liable for income tax on the full FMV at the point of vesting:
- FMV at vesting: $5/share
- Amount of RSUs vested: 25 (out of 100)
Taxable gains = 25 x $5 = $125 (Subject to ordinary income tax)
Your company may withhold a portion of your shares to cover this or require that you pay the amount directly in cash.
After the vesting period is complete, you can sell your vested RSUs anytime. If you’ve held the shares for one year or less before selling and the selling price is higher than the FMV of your stocks (i.e. short-term capital gains), you will be taxed at your federal ordinary income tax rate. Otherwise, it is considered long term – typically lower than federal ordinary income tax rates.
- FMV at sale: $15/share
Taxable profits = $15 – $5 = $10 (Subject to long term capital gains tax)
Some, however, would decide to hold onto their RSUs after they vest due to a strategic investment decision – thinking that the company share value will increase substantially over time.
RSAs at termination
It’s common to wonder about your own RSAs when you decide to leave the company. There’re two situations here: leaving with vested RSAs and unvested RSAs. If you don’t quite remember the RSA vesting concept, quickly review it:
- Vested RSAs: Company shares that you can sell
- Unvested RSAs: Company shares that are issued to you but can’t be sold until they vest (or become available to sell).
Quitting with vested RSAs
That’s simple. You can keep all of the vested shares during a termination event. Your departure from the company has no effect on your ownership.
Quitting with unvested RSAs
While unvested RSA shares are subjected to repurchase upon termination, your company can purchase the shares back from you at the same price at which you paid for them initially. But we need to bear in mind that it’s also fine for companies not to repurchase the shares back.
So, a vesting schedule agreement is important for every party to understand what will happen when an employee leaves the company.
RSUs at termination
When it comes to RSU at termination, there’re also two situations:
- Vested RSUs: Company shares that you now own
- Unvested RSUs: Company shares that you’ve been promised but haven’t yet owned until you’ve met the conditions such as a period of time or performance.
Quitting with vested RSUs
Like RSA tax treatment, when you decide to leave, the vested RSUs will stay yours as you own company shares after vesting.
Remember: In a private company, your RSUs could have a ‘’Double Trigger Vesting’’ mechanism. Even if the first trigger passes (i.e. the vesting date arrives), you may need to wait until the company goes public (i.e. the second trigger) before you can quit and still maintain ownership.
Quitting with unvested RSUs
Quitting with unvested RSUs means you lose the right to receive company shares.
As we just reviewed the concept of unvested RSUs, your company promises to grant you the RSUs only if you meet some conditions, e.g. stick around for a certain period of time. Since you can’t do it, it’s fair that you forfeit your right to those shares.
RSA vs RSU: Which type is right for you?
RSAs are more popular with early-stage companies when the FMV of common stock is low and it is difficult to compete with the more established competition on salaries.
RSUs can be a better fit for more established companies. When the company has a track record of success, that means a higher FMV, which will in turn demand a higher strike price for RSAs, which, in turn, will reduce their attractiveness. In that scenario, RSUs make more sense.
No worries, it’s easy to lose your way somewhere along that path. We get it. That’s where Global Shares can come in, with our expertise in all equity compensation matters waiting to be put to work for your benefit. Contact us today to find out more about how we can help you to set up your plan.
FAQs of Restricted Stock
What is restricted stock?
Restricted stock is an award of stock issued to a person. The person doesn’t have the right to the stock until all conditions are met, e.g time and/or performance. It is commonly issued to corporate officers such as directors and senior executives.
What is the difference between RSA and RSU ?
RSA and RSU are restricted stock and a grant of company stock offered to employees in a form of compensation. At grant, RSA shares are issued to employees and they’re normally required to purchase them but they can’t sell them until they vest. But under an RSU, employees pay nothing and no shares are issued at grant. Instead, they’re promised to receive the shares or the cash equivalent after all vesting requirements have been met. To learn more, read our ‘’RSA vs RSU’’ guide now.
Do you pay capital gains tax on RSU?
Yes. You need to pay capital gains tax on RSU shares when selling them at a price that is higher than the FMV of your stock. You will be taxed at your federal ordinary income tax rate if you’ve held the shares for one year or less before selling (i.e. short-term capital gains). Otherwise, it is considered long term – typically lower than federal ordinary income tax rates.
Should I sell RSU right away?
Usually, it is recommended to sell your RSUs immediately after the vesting period. There will be no capital gains tax due by selling them right away before they increase or decrease in value.
Please Note: This publication contains general information only and J.P. Morgan Workplace Solutions is not, through this article, issuing any advice, be it legal, financial, tax-related, business-related, professional or other. J.P. Morgan Workplace Solutions’ Insights is not a substitute for professional advice and should not be used as such. J.P. Morgan Workplace Solutions does not assume any liability for reliance on the information provided herein.
