RSU Basics: A Guide for Equity Plan Professionals

Restricted stock units (RSUs) are the most common form of equity compensation issued by public companies—and their use among private companies is growing. If you manage equity plans, understanding RSUs is essential. This article breaks down the fundamentals of RSUs that every equity plan professional needs to know, covering what RSUs are, how they are taxed, how they compare to stock options, and best practices for RSU administration.

What Are RSUs?

RSU awards are a way that companies can use stock to compensate employees. The “units” are a means demarcating the amount of stock (or stock value) the award holder is entitled to. Typically, each unit represents one share of stock. If the award holder fulfills the vesting requirements, the company will pay out the award, either by issuing the shares represented by the units or by disbursing the cash value of the shares to the award holder.

For trends in how public companies use and design RSU awards, see the blog “5 Trends in Full Value Awards”

Why Units Instead of Stock?

It’s certainly possible for companies to simply issue stock to employees and make sale of the stock subject to vesting conditions. This arrangement is called “restricted stock.” But it can be more complicated than granting RSUs. The company would have to instruct the transfer to issue the stock and establish some means of preventing the award holder from selling the stock until the vesting conditions are met. The award holder would have dividend and voting rights on the stock. And if the vesting conditions aren’t met, the company has to cancel the certificate or otherwise reacquire the stock.

Most companies find it easier to wait until award holders meet the vesting requirements to issue the stock. This means that award holders won’t have voting or dividend rights during the award vesting period. Some companies pay dividend equivalents, sometimes called dividend equivalent units (DEUs) or dividend equivalent rights (DERs) to RSU award holders. This entitles them to payment that is equivalent to the dividends paid to shareholders.

How Are RSUs Paid Out?

Once the RSUs vest, they are paid out to the award holders. Most RSUs are paid out in stock, but, as noted above, the company could pay out the cash value of the shares. Most RSUs are paid out immediately upon vesting.

In some cases, RSUs can be subject to deferred payout, meaning that they aren’t paid upon vesting. They might be paid out on a specified date, a specified number of years after vesting, or when the award holder terminates employment. This type of RSU arrangement is not as common as RSUs that are paid out upon vesting; you can learn more about it in the article Deferred Stock Units.

How Are RSUs Taxed?

As with any type of equity vehicle, it is critical to understand the tax implications of RSU awards:

• When an RSU is paid out, the participant will recognize compensation income equal to the value of stock (or cash payment).
• For US employees, employers are obligated to withhold federal, state, and sometimes even local taxes on the income award holders recognize at payout and report the income on the employee's Form W-2. 
• When US employees sell shares acquired under an RSU, any gain or loss relative to the value of the stock back when the award was paid out will be treated as a capital gain or loss, taxed at either long-term or short-term rates, depending on how long the shares were held after release.
• The employer has no withholding or reporting obligations for any capital gains income employees may earn after the awards have been paid out; employees are responsible for reporting and paying taxes on capital gains when filing their tax returns. 

The tax consequences outside the US can vary by country. Many countries tax RSUs in a manner that is similar to the United States, but this isn’t always the case. The NASPP Blog Global Stock Compensation: Key Considerations and Resources suggests resources you can use to research the tax treatment of RSUs in other countries.

For more information on the US tax treatment of RSUs, check out our blog on “Taxable Events for RSUs.” 

RSUs vs. Stock Options 

RSUs and stock options are two popular forms of equity compensation, each with their own unique advantages. RSUs are typically considered less risky because award holders don’t have to pay for stock underlying their awards. As a result, RSUs are always valuable, regardless of the company’s stock price trajectory.

Recipients of stock options, however, must pay for the stock they acquire under the option. This price is usually the value of the stock at the time the option is granted. Because of this, options will only deliver a benefit to the holder if the stock price increases after the option is granted.  

RSUs in Private Companies 

Private companies, especially early-stage companies that expect to experience a lot of growth, often prefer to grant stock options, rather than RSUs.  But as private companies mature and reach a size that is comparable to public companies, they sometimes start to shift to RSUs.

When private companies grant RSUs, they often use “double-trigger” vesting requirements. This means that vesting is contingent on two conditions:

1. continued service, and
2. an IPO or change-in-control (CIC)

Making vesting contingent on both of these conditions effectively delays taxation of the RSUs, at least for US federal income tax purposes, until the company’s stock is publicly traded (sometimes the second condition is not the IPO itself but the end of the company’s post-IPO lock-up period). In the United States, this prevents the employee from having to pay income taxes on the award until the underlying stock is liquid and can be sold to cover the taxes. In some cases, a portion of the IPO proceeds are used to cover the taxes due on RSUs.

Navigating RSUs as a Stock Plan Administrator 

As a stock plan administrator, your role is pivotal in managing RSUs. Here are some strategies to help you handle RSUs effectively.  

Communication: Keeping employees informed about their vesting schedules and tax implications can alleviate a lot of confusion and potential frustration. Check out our resources on Participant Education.

RSU Administration: Efficiently managing vesting schedules, tax withholding, and employee terminations can significantly reduce administrative overheads and potential mistakes. Check out our resources on Restricted Stock and RSUs.

Understanding Regulations: Staying updated with IRS rules and regulations related to RSUs will help ensure that the company remains compliant and can avoid any penalties. See our Guide to Restricted Stock and Unit Plans for a discussion of all the rules and regulations that apply to RSUs. 

Helping Employees Understand RSUs: While you can't provide personal financial advice, informing employees of the risks associated with equity compensation will allow them to make informed decisions concerning their awards.  Read about how one company educates employees on RSUs.

Learn More About RSU Administration

The NASPP’s Stock Plan Fundamentals program covers the basics of how RSUs are taxed and day-to-day procedures necessary to manage award programs.

Take your understanding of RSUs to the next level with our on-demand course “Restricted Stock Unit Essentials,” which provides more in-depth information on how to manage RSU awards, including vesting schedule administration, tax withholding strategies, and compliance best practices for equity plan professionals.