A lot of my clients receive RSUs. In public companies. But what if you work for a private company?
That’s not so straightforward.
But they carry the same promise of money, for you, my dear. So it’s important to understand how they work, and how they can work for you, specifically.
How RSUs Work in a Public Company
RSUs in public companies are delightfully straightforward, compared to other kinds of stock compensation. (Oh god don’t get me started on incentive stock options…) Here’s the high-level:
- You don’t own anything until an RSU vests.
- The moment the RSU vests, you immediately receive shares in the company…and you owe income taxes on their value.
- Congratulations, you are now a shareholder, and a little bit (or a lot bit) richer.
How RSUs in Private Companies Are Different
In a way, there’s nothing different between private and public company RSUs. You wait until the RSUs vest. When they vest, you have to pay taxes on them.
But if you work for a private company, you have a problem:
If your RSUs vest when your company is still private, you’ll owe taxes but not be able to sell the shares for the money you’ll need to pay the taxes.
Why can’t you sell the shares? Because your company is private! (This is starting to feel circular.)
So, now you have a tax bill and all you have to pay it with is cash out of your pocket, because, as it turns out, cash is the only thing the IRS accepts. This means you’re putting your existing money on the table to pay taxes on this stock that may or may not be worth something in the future. That’s risky.
There are, of course, a few efforts to enable trading of private-company stock on “secondary” markets, like Nasdaq Private Market and EquityZen. However, those markets are nowhere near as large, easy to use, safe, or sometimes even merely available as the good ol’ New York Stock Exchange or NASDAQ (aka, “the stock market”).
Two Solutions to this Tax Problem
Pretend I have some useful introductory sentence here.
Thankfully, most companies I see recognize this problem and structure their stock plans to help you, the employee, avoid it. They do this by having a “double trigger” vesting requirement, which means the shares aren’t really truly yours until (in the cases I’ve seen):
- The vesting date arrives, and
- The company goes public (or some other liquidity event that would enable you to turn these shares into money)
As, Garrett Perez, one of my favorite CPAs (he specializes in all these finicky tech-industry issues), observes,
Most companies who do in fact issue RSUs have this requirement [of double-trigger vesting] as it would be extremely punitive on their employees to have them recognize it as income with essentially no market to sell it in. I’ve never seen a pre-ipo company that does not have the double vesting requirement.
So, if your company has such a double trigger vesting schedule—which it likely does—these now become a lot more like public-company RSUs…because the shares don’t become yours until the company is public.
If your company does not have this double-trigger vesting, and you do in fact owe taxes before you can sell the shares for money, then the new-in-2018 tax law might help. Specifically, the new 83(i) tax election.
This election allows you to defer paying the taxes by 5 years…which hopefully is enough time to turn those shares into actual money. Possibly the most important thing to remember is: You must make the 83(i) election within 30 days of the RSU vesting. (In this way, it’s similar to the 83(b) early exercise election for stock options.)
Alas, a company has to check a lot of boxes before their stock-grant plans are eligible for 83(i), and many aren’t. Your company should notify you and its other employees if the stock you’re receiving is 83(i) eligible.
How to Actually Plan for the RSUs
The first step is going to be to read the RSU grant document that you received from your company. Really. Please read it. At the very least the first few pages, where usually most of the good stuff is.
It will explain how many RSUs you have, when they will vest, what will happen if you leave the company after the first vesting trigger but before the second, etc. There’s some important sh*t in there, people!
I’m going to assume, for the rest of this post, that we’re talking about RSUs with double-trigger vesting, which won’t finish vesting until your company goes IPO.
Worst. Tax Year. Ever. On the Upside, Best Income Year Ever!
Let’s say your RSU first vesting trigger (a specific date) has come and gone. You own the company stock…almost. But the stock isn’t truly yours until the company IPOs. With IPOs comes a “lockup period” of 90-180 days, after which your RSUs finally, fully vest.
But if your vesting dates have been happening for several years now, you’ve been building up quite the collection of not-completely-vested RSUs. Now that your company has IPOed and the lockup period is over, BAM! they all finish vesting on the same day. And you owe taxes on every last one of ‘em.
Let’s walk through an example:
- 4000 RSUs are granted to you on March 1, 2015.
- Each year, 1000 hit their first vesting trigger on March 1.
- On March 1, 2019, after 4 years, you have 4000 RSUs, all of which have hit their first vesting trigger, but not their second.
- Your company IPOs and the lockup period passes.
- All 4000 RSUs simultaneously hit that second vesting trigger and become really truly yours.
- Now, instead of having paid taxes on 1000 RSUs each year, you’re paying taxes on 4000 RSUs in a single year.
This could even push you into a higher tax bracket, not to mention the big bucket of extra money that you’re paying taxes on. That tax bill could make a Grown Woman Cry.
But don’t fret! The reason your taxes are so high is because your income is so high! Yeah you!
Great Opportunity for Charitable Giving
I’ve written and talked a bunch about the gratifying tax-savviness of donating company stock to charity. You donate $1000 in company stock, the charity receives a full $1000 in value, and you get to avoid the tax bill that you would otherwise incur by selling it. This is really helpful when your company stock has grown a lot since you acquired it…because the tax bill for selling would be high.
Now, with RSUs, you are fully and unavoidably taxed on the value of the RSUs when they finally vest. You could sell them the next moment and not owe any additional tax. So, the above strategy doesn’t make sense.
However, the year all your RSUs vest can still be a really good year to make charitable contributions. Why? Because if all of your RSUs vest at once, you might get pushed into a high(er) tax bracket. And the tax benefit to you of donating to charity goes up with your tax bracket.
If your top tax rate is 35%, then donating $1000 will save you $350. (Admittedly, you’re still “out” $650, so it’s not a money-saving maneuver overall.) By contrast, if your top tax rate is 24%, then donating $1000 will save you only $240, and you’re out $760.
If you’re charitably inclined, as they say, and planning to donate anyways, then it might be worth “bunching” charitable donations in the year that your RSUs are going to all vest.
Who Knows What the Stock Will Be Worth. So Let’s Run Some Scenarios!
Stock in a private company is risky. It’s even harder to predict the future value of private-company stock than public-company stock, which itself is notoriously elusive. So, whatever your private-company stock is worth now is probably not what it’s going to be worth when the stock becomes really and truly yours.
Even so, it’s important to plan ahead for that money, even not knowing how much it’ll be. Because You Know if you just dither along and all of a sudden your paycheck is 10x the usual, you’ll probably waste a whole bunch of it and kick yourself later.
I have clients with vested RSUs in Uber, for example. I don’t think it’s likely that Uber—and therefore their stock—will be worth nothing when the company eventually IPOs. But no one can reasonably predict how much it will be worth. It could be worth a lot more than it’s valued at now, could be a lot less (let’s say the federal government starts making laws about rideshare services or independent contractors vs. employees). Kinda hard to plan around that.
So, play with several scenarios! What if the stock is worth what it’s worth now when it finally becomes yours? How about 2x? How about only ¼?
How would that affect your plans?
How would you change your plans?
What would you do with the money?
I actually loooove this part of financial planning. The “I gots NO IDEA what my future holds, but let’s see what it COULD hold and make sure we’re ready when that comes!” And if you’re lucky enough to get RSUs in a company that eventually does well, and you’re smart and diligent enough to do the work to understand and plan for it, then you just did Future You a big big favor. You gave her a lot more opportunity and choice than the Now You has.
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Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Meg Bartelt, and all rights are reserved. Read the full Disclaimer.