Updated July 19, 2023
Definition of Restricted Stock Units
Restricted stock units (RSUs) refer to the value granted in a company’s common stocks to the employees by an employer as a part of compensation through a well-defined vesting plan and a schedule of distribution based on the accomplishment of set performance milestones or based on a requirement to serve a minimum number of years with the company.
Explanation
RSUs form part of compensation plans offered by companies. In these plans, employees are granted an interest in a fixed number of units of the company’s common stocks. This means that the units vest in favor of the employees per the company’s vesting schedule. At the vesting date, the employees can get either the units or cash based on the fair market value of the units as on the vesting date.
Example of Restricted Stock Units
Suppose a company offers the employee 500 units of restricted stock units as part of the compensation plan in addition to the regular salary. The vesting conditions suggest that the employee must stay with the company for five years to qualify for the stock units. After five years, the employee can call in 500 units of stock or an equivalent cash value based on the stock’s fair market value on the vesting date. This is an example of a restricted stock unit plan.
How to Tax Restricted Stock Units?
The stock units or cash awarded to the employees at the vested date per the fair market value are the employee’s ordinary income for that year. The payment is based on the stock’s fair market value on the vesting date. The company is required to withhold tax on RSU payouts, and the remaining shares or cash, after deducting taxes, is distributed to the employees. An employee can either hold the claims, or they can sell them.
How is Stock Limited on Restricted Stock Units?
Under RSU plans, the employer promises to pay employees a fixed number of standard stock units or a cash equivalent after completing the vesting period. The number of units the company wants to entitle employees to is based on the company’s assessment of their roles and capabilities.
- The number of years an employee must serve in the company before the right to share vests is limited.
- The performance-based or milestone-based limitation is as follows: Finishing a certain milestone, such as a project, may be subject to a condition.
- A combination of the above two restrictions
Advantages
Restricted stock units are advantageous for the employer as well as the employees in the following ways:
- The company can retain talented employees, saving them from the loss they would incur on the early resignation of such employees.
- The company is deferring the payments for the future instead of making an upfront payment, hence saving its cash flows.
- The employee gets ownership interest in the company once the option vests.
- In addition to the shares, employees may also have the option to receive an equivalent cash value instead.
Disadvantages
Some limitations that employers and employees face in the case of restricted stock units are as follows:
- The exact amount of compensation for employees is unknown to the company initially, as it depends on the fair market value of the RSUs on the vesting date. Additionally, there is a possibility that the stock’s value may not appreciate as expected by the employees.
- If the employees want to leave the company before the vesting period, they will have to forego their rights.
Conclusion
Restricted stock units are an excellent option to retain employees with the company. A benefit of RSUs is that the employees don’t have to bear any cost, which is part of their compensation plan.
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