Tuesday, June 14, 2011

Restricted Stock Units (RSU) -- Potential to be Double Taxed! – Part 1 of 2

If your employer grants you RSUs (Restricted Stock Units), count your blessings. This is a method of rewarding employees for exceptional contributions, loyalty, or just wanting to say “thanks”. However, there are some things that you should know about the way RSUs are treated from an income tax perspective so that you will not be double taxed.

First of all, RSUs are taxed as ordinary income to you, not capital gains. This sometimes confuses people because most of the time stocks and capital gains go together.  When your employer grants RSUs to you, there is a restriction associated with them. Usually, the restriction is that you cannot sell the stock until a certain amount of time has passed, aka vesting period.  Typically, an employee will vest in a certain percentage of the granted RSUs every year. For example, it could be that your employer granted 400 RSUs to you that proportionally vest over a 4 year period. This means that you will be vested in 100 RSUs every year for the next 4 years. Every year, once the vesting period is passed, two things happen.  Your employer will add the value of the RSUs that vested to your income. And, you will be able to sell the vested RSUs.

Large employers usually relegate the RSU transactions to a broker.  Your employer might initially set up the account for you, and then you can see how many RSU you have, and when they will vest. Once you become vested in the RSUs, your employer will add the value of the RSUs to your income (assuming an 83(b) election was not made).  He’s also obligated to withhold taxes from the distribution, usually referred to as backup withholding. If your employer uses a broker to handle the RSUs, he’ll require that just enough of the vested RSUs be sold to potentially cover all income and social security taxes resulting from the vesting. This is known as Sell to Cover. However you can select another option to sell all of the vested RSUs. This is usually referred to as a Same Day Sale.  If you elect the Same Day Sale option, after deductions proceeds are deposited into your cash brokerage account.

Here is an example of how the double taxation can occur. Let’s say your employer granted 1000 RSUs to you last year. You become vested in 250 shares this year. On the day that you become vested, the stock value is $50. Also, let’s say that you setup the Same Day Sale option in the brokerage account.  On the day that you become vested, your broker will sell 250 shares of stock on your behalf.  The gross amount from the sale is $12,500 (250sh * $50/sh). However, your broker will probably withhold a fee, maybe $100, for executing the transaction. And, your broker will transfer some amount to your employer to help pay the taxes due. Assume it’s 28% of the sale, or $3500. Whatever is left over, $8900 in this case, is deposited into your cash account at the brokerage firm.

Your end-of-year W-2 will show that you received $12,500 of additional income, and it will also show the $3500 of additional tax paid. Also, you broker is going to issue a 1099-B to you, and therein lies the problem. In this example, your broker should report net proceeds of $12,400 ($12,500 - $100 commission). You must report this 1099-B transaction on your income tax.  How you handle it is very important. Your cost basis on the transaction is what the stocks sold for, $12,500. So this essentially turns out to be a short term capital loss on your Schedule D.  If you fail to report it, the IRS will assume that your cost basis is zero, and will want you to pay the additional income tax, plus interest and penalties.  I’ve seen some people report the transaction with zero cost basis because their employer gave them the stock! Ok, it was a gift, but the employer has already withheld a portion of the proceeds for taxes.

Next, I’ll discuss the Sell to Cover option, and how you can end up on the short end of the stick.

Brycast Financial Planning in Austin Texas --- We Can Help
Income Tax Preparation in Austin Texas

contact: service@brycast.com http://www.brycast.com/  (512) 293-4170
Enrolled Agent; Investment Advisor Representative

1 comment:

  1. Huh? Yeah, that was my reaction when I was told you can get paid good money to use Facebook.
    But I checked it out and I loved what I found.

    If you know how to use Facebook then you can generate a serious income doing this, too.
    Click below to get all the details:

    https://socialsalerep.com?hyden5496

    ReplyDelete