RSU tax strategies
Lesson in Course: Finance at work (advanced, 4min)
I am at a late stage startup or my company has already gone public. What are some ways I can save on taxes?
What it's about: Tax strategy to deferred income tax owed on vesting RSUs for 5 years.
Why it's important: Startup employees often can't afford to pay the income tax for RSUs without a double trigger.
Key takeaway: File an 83(i) within 30 days of the grant date for RSUs.
RSU (restrictive stock unit) taxation works the same way as RSAs (restrictive stock award) without an 83(b) election. We owe ordinary income taxes when our shares vest and pay capital gains taxes when we sell the shares.
However, one benefit of RSUs is that we don't have to pay for the shares upfront as we do with RSAs. Instead, the IRS considers the entire value of the RSU (shares x price) on the vesting date taxable which creates the problem of building up a large tax bill on the vesting date. This problem really hits home for employees of private companies who can't yet sell their shares to help pay for the taxes.
Fortunately, we can file an 83(i) election.
A letter to the IRS to defer the taxes owed on vested RSUs for up to 5 years or until a disqualifying event.
For an 83(i) to be effective, we need to file it within 30 days of the grant date of our RSU.
An 83(i) is a huge benefit for startup employees because it solves the problem of not being able to pay the income taxes owed when the shares vest. However, once the 5 year period is up, we will be on the hook for the deferred taxes. Since companies are staying private longer, some companies have implemented employee-friendly double-trigger vesting to give employees more than 5 years to prepare.
A vesting schedule that requires two conditions to be met before shares are released to an employee.
Facebook (Meta) is an example of a company that solved the RSU tax problem by applying double-trigger vesting.
Facebook added a second condition to the vesting of RSUs in addition to the primary condition of time-based service at the company. Under the second condition or double-trigger, the RSUs would not vest until the company was acquired or went public. This held off the vesting, and therefore the tax bill, of the RSUs until the employees were able to sell their shares to cover the taxes.
Selling shares to cover taxes
If we work at a public company or if a liquidity event is planned for our startup, our shares can be freely sold to cover the taxes owed.
To pay for taxes owed on vesting shares, we can choose a strategy to sell to cover.
Selling to cover is a tax strategy where a portion of vested RSUs is sold right away to pay for taxes owed for the vesting period.
We were granted 1,000 RSUs by a public company that we work for and the shares vest at $50 per share. We have a reported income of $50,000 from our vested RSUs and we owe roughly $15,000 in ordinary income taxes.
Sell to cover will sell 300 of those shares at $50 per share on the day they vest to cover the income taxes. We keep the remaining 700 shares.
Sell to cover is a very popular strategy that is fully automated by brokerages. Meaning, all we have to do is to elect to turn it on and every time our RSUs vest, shares are automatically sold to cover the tax.
Actionable ideas
83(i)s for startup employees should be prioritized and filed right away before 30 days have passed. 83(i)s don't apply to employees at public companies since the shares are freely traded on the public exchanges.
While RSUs offer us more tax flexibility than RSAs or stock options, figuring out our income tax owed can be tricky. Tax can vary based on various factors such as holding RSUs or selling right away. If you need help, reach out to an expert on Archimedes today.
Supplementary materials
For extra insight, check out the video by expert Mike Zung, CFP® over on the Watch tab!
Gain the confidence to make investing a bigger part of your life
Read the IRS guidance on 83(i).
SVB Private Bank looks at Section 83i and what's needed for companies to qualify for this tax-saving advantage.
Glossary
A vesting schedule that requires two conditions to be met before shares are released to an employee
A letter to the IRS to defer the taxes owed on vested RSU for up to 5 years or until a disqualifying event.
Selling to cover is a tax strategy where a portion of vested RSUs is sold right away to pay for taxes owed for the vesting period.