Offer Letter Basics: RSU taxes and how it works

offer letter RSUs

Revised as of January 2024

How do you evaluate an offer from a large tech startup or established tech company like Microsoft or Google?  The first step in evaluating your offer is to understand it!  Below, we discuss one of the components of your offer letter – how Restricted Stock Units (RSUs) and RSU taxes work.

Restricted Stock Units (RSUs)

Structure: Each RSU equates to a share of the company stock.  ex.  1 Google GSU = 1 GOOGL stock.

Value: RSU value is tied to the price of the actual traded stock price.  RSUs are a little different than stock options, and have an implicit value above $0.  As long as there is a stock price at vesting, then your RSUs have value.

Vesting: The initial RSUs grant generally vest over a few years with a 1-year cliff.  The 1-year cliff requires you to be an employee for at least a year before receiving any portion of vested stock.  At vesting RSUs are taxed.

RSU Taxes:. At the time of vesting, withholding for taxes is made.  Depending upon your overall income level, this may or may not be enough to fully cover your tax bill at tax return time.  Federally, the withholding tax rate on stock compensation starts at 22% and then converts to 37% on stock compensation above the $1 million mark.

Other general vesting requirements/rules:

  • Look at the small print – when you terminate employment, vesting stops immediately.
  • If you are considering parental leave, look to see if your RSUs stop vesting during any non-paid leaves.
  • Unlike stock options, your RSUs become actual shares at vesting and do not expire like stock options would.
  • Think the company will go gangbusters over the next few years?  Review your incentive stock option plan to understand if you may make an election to pay tax on the value of the RSUs now (Section 83(b) election).  Talk to your accountant or financial advisor, since this does come with significant risks.
  • Trading window: once your RSUs vest into stock, you will only be allowed to trade the stock at set windows through the year.  This prevents insider trading.  If you have a large set of RSUs vesting, you may decide to make a 10b5-1 trading plan for regular scheduled sales over a period of time.

1 Year Cliff Taxation: RSUs are generally taxable as ordinary income when vested.  The first year this happens can be a bit of a shock for some.  Watch our YouTube video HERE for a visual breakdown of what will happen.

Single Trigger vs Double Trigger RSUs:  RSUs can have different vesting requirements.  Most private companies offering RSUs provide ‘double trigger’ RSUs.  These require time vesting and an exit (IPO, acquisition, etc) before the RSUs fully vest to you and become compensation income.  If you have double trigger RSUs, check out this blog post for more information.

What are the main issues surrounding RSUs?

When you are negotiating your offer – most of the time they will have an internal analysis to support RSU and salary trade-offs.  As long as they keep within the boundaries of the model, then your ‘target compensation’ will be the same, from their view point.  This allows you to toggle up or down your own risk level.

So how do you feel about RSUs vs. cash salary?  Keep these things in mind when weighing your options.

Cash flow impact: Withholding RSU taxes are usually paid through a portion of RSUs sold at vesting.  These taxes paid are generally displayed on your W-2 as part of your total tax withheld.  Most larger tech companies will offer a signing bonus to help you transition to the RSU schedule for the first year.  The goal of this sign on bonus is to act as additional incentive to wait for the 1 year cliff vesting date.

Investment strategy: If you receive a large grant of RSUs, you will have many risks.  Risk of termination before vesting, risk of market volatility in stock price, and asset concentration are a few.  You will also want to decide if you will be keeping the stock once vested, or if you prefer to sell the stock.

Evaluating many offers:  Evaluating RSUs and stock options 1 to 1 is generally not appropriate. Employees will generally receive fewer RSUs than stock options since RSUs do not depend on company performance to the same degree. Evaluate your options with your accountant or financial advisor..

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The above discussion is for informational purposes only. Recommendations are of a general nature, not based on knowledge of any individual’s specific needs or circumstances, and there is no intent to provide individual investment advisory, supervisory or management service

How to negotiate your next compensation package

When deciding to leave a company and begin a new adventure, prepare for your compensation negotiation. Once you choose your new path, how do you maximize your financial outlook as well?

Many technology-based companies view attraction or retention of key employees as their #1 problem.  There is demand for talent in a limited pool of individuals. The majority of these employers rely on irregular bonuses – spot awards, ad hoc grants, and non-cash benefits – to hold on to key employees.

So how do you get the most out of your career with the company?

  1. Start with transparency – ask important questions around the health of the organization and the stock option pool.
  2. Discuss your executive compensation package to ensure you understand the implications of:
  • Long-term incentives
  • Peripheral negotiations around severance, vacation days, etc.
  • Terminology used in your vesting agreement

Remember: Negotiate for what is fair – they are offering you a job you love.

3.  Conclude with shared meaning – you both want long-term value creation.

Long-Term Incentives (LTIs)

As you head to the managing and executive level of business the ratio of LTIs to total compensation increases. Many mid- to large-companies provide current value awards (RSUs or phantom units). Some smaller tech startups will provide retroactive grants to give you in-the-money options.

Review your performance-based plan. Is there a cash component? Only equity? Consider the risk you are willing to take. Do you need more cash annually to set aside for your financial goals? Can you take the risk of asking for a heavier equity allocation? What are the tax effects?  Depending on where the company is with their cash, it may be easier to obtain additional equity compensation than salary.

Peripheral Negotiations

When you reach the maximum compensation a company is willing to give you, ask for additional protections or benefits.

Do you like to travel often? Discuss what a typical week looks like and when working from home may be allowed. Ask for additional vacation days. If they have a plan with levels of additional days per number of years worked, you may be able to ask for the highest level benefit.

Are you taking a huge risk in a department that may flop or go big? Consider asking for a short time frame of severance if you are terminated. A safety net to get back on your feet can make a huge difference mentally.  Just make sure you read the terms closely to know under which scenarios pay out will occur.

Ensure your agreement includes indemnification protection. Directors receive it, and as an executive you should too.  If applicable, think about an umbrella insurance policy and directors and officers policy.

Terminology

Make sure you understand the terminology in your vesting agreement.

When the vesting schedule accelerates

  • Acceleration based on termination – Does this mean any termination? Termination without cause? Leaving for good reason?
  • Acceleration based on a merger or acquisition (change in control single trigger) – Do you receive an additional year of credit? Or a shorter or longer time period?
  • Understand when your vesting accelerates and when it doesn’t.  This will help you evaluate the risks of your incentive compensation long term.

Golden Parachute / Tax Gross Up

Key employees may receive severance packages. If your agreement pays out three times your average compensation (over the past five years) at the end of employment, review your agreement to ensure you receive a 280G payment projection.

A 280G payment is an additional tax burden for ‘golden parachute’ severance packages.  The 280G payment projection will display potential tax due and any gross up of taxes by the company.

The gross up would include income and excise taxes due for golden parachute packages. Also, ask for a reimbursement for additional expenses in connection with an IRS audit claiming further tax due to the 280G payment and gross up. You shouldn’t be liable for a miscalculation made by the company in grossing you up for the applicable tax.

Thoughtful conversations around executive compensation can make a distinct difference over time. Planning for a successful negotiation with your new company allows you to focus on your job and know the risks and rewards applicable to you.

If you aren’t sure where to start, contact us about a quick start project to help you.

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The above discussion is for informational purposes only. Recommendations are of a general nature, not based on knowledge of any individual’s specific needs or circumstances, and there is no intent to provide individual investment advisory, supervisory or management services.