What Is a Restricted Stock Unit (RSU)?
A restricted stock unit (RSU) is a form of compensation issued by an employer to an employee in the form of company shares. Restricted stock units are issued to an employee through a vesting plan and distribution schedule after achieving required performance milestones or upon remaining with their employer for a particular length of time.
RSUs give an employee interest in company stock but they have no tangible value until vesting is complete. The restricted stock units are assigned a fair market value when they vest. Upon vesting, they are considered income, and a portion of the shares is withheld to pay income taxes. The employee receives the remaining shares and can sell them at their discretion.
- Restricted stock units (RSUs) are a form of stock-based employee compensation.
- RSUs are restricted during a vesting period that may last several years, during which time they cannot be sold. Once vested, the RSUs are just like any other shares of company stock.
- Unlike stock options or warrants which may expire worthless, RSUs will always have some value based on the underlying shares.
- For tax purposes, the entire value of vested RSUs must be included as ordinary income in the year of vesting.
Understanding Restricted Stock
Restricted stock as a form of executive compensation became more popular after accounting scandals in the mid-2000s involving companies like Enron and WorldCom as a better alternative to stock options. At the end of 2004, the Financial Accounting Standards Board (FASB) issued a statement requiring companies to book an accounting expense for stock options issued. This action leveled the playing field among equity types.
Previously, stock options had been the vehicle of choice, but with scandals, malpractice, and issues of tax-evasion, companies were (as of 2004) able to consider other types of stock awards that might be more effective in attracting and retaining talent. Soon, restricted stock units, which before had typically been reserved for higher levels of management, were being granted to all levels of employees around the world.
Accordingly, the median number of stock options granted per company by Fortune 1000 firms declined by 40% between 2003 and 2005, while the median number of restricted stock awards increased by nearly 41% over the same period.
Restricted Stock Unit (RSU)
Advantages of Restricted Stock Units
RSUs give an employee an incentive to stay with a company long term and help it perform well so that their shares increase in value. If an employee decides to hold their shares until they receive the full vested allocation, and the company's stock rises, the employee receives the capital gain minus the value of the shares withheld for income taxes and the amount due in capital gains taxes.
Administration costs are minimal for employers as there aren't actual shares to track and record. RSUs also allow a company to defer issuing shares until the vesting schedule is complete, which helps delay the dilution of its shares.
Limitations of Restricted Stock Units
RSUs don't provide dividends, as actual shares are not allocated. However, an employer may pay dividend equivalents that can be moved into an escrow account to help offset withholding taxes, or be reinvested through the purchase of additional shares. The taxation of restricted stocks is governed by Section 1244 of the Internal Revenue Code.
Restricted stock is included in gross income for tax purposes, and it is recognized on the date when the stocks become transferrable (also known as the vesting date). RSUs aren't eligible for the Internal Revenue Code (IRC) 83(b) Election, which allows an employee to pay tax before vesting, as the Internal Revenue Service (IRS) doesn't consider them tangible property.
RSUs don't have voting rights until actual shares get issued to an employee at vesting. If an employee leaves before the conclusion of their vesting schedule, they forfeit the remaining shares to the company. For instance, if John's vesting schedule consists of 5,000 RSUs over two years and he resigns after 12 months, he forfeits 2,500 RSUs. (For related reading, see "How Restricted Stock and Restricted Stock Units (RSUs) are Taxed.")
Examples of RSUs
Suppose Madeline receives a job offer. Because the company thinks Madeline's skill set is valuable and hopes she remains a long-term employee, it offers her 1,000 RSUs as part of her compensation, in addition to a salary and benefits.
The company's stock is worth $10 per share, making the RSUs potentially worth an additional $10,000. To give Madeline an incentive to stay with the company and receive the 1,000 shares, it puts the RSUs on a five-year vesting schedule. After one year of employment, Madeline receives 200 shares; after two years, she receives another 200, and so on until she acquires all 1,000 shares at the end of the vesting period. Depending on how the company's stock performs, Madeline may receive more or less than $10,000.
As a real-world example of what a company does to issue RSUs, take a look at December 2017 SEC Form 4 filed by the electric vehicle company Tesla, Inc. (NASDAQ: TSLA). This form indicates that Eric Branderiz—the company's former chief accounting officer—who received some restricted stock, wished to convert 4,808 restricted stock units into common shares.
Source: SEC EDGAR
Frequently Asked Questions
What are restricted stock units?
Restricted stock units are a type of compensation in which a company gradually transfers shares to an employee. Depending on the performance of the company, restricted stock units can fluctuate in value. From a company’s perspective, restricted stock units can help employee retention by incentivizing employees to stay with the company long-term. For employees, restricted stock units can help to share in some of the upside associated with a company’s success, occasionally producing very substantial income.
What is the difference between restricted stock units and stock options?
Stock options provide employees with the right—but not the obligation—to acquire shares at a specified price, which is typically higher than the market price prevalent at the time the options are given. This typically means that the employee benefits only if the company’s share price rises within a specified period of time. Restricted stock units, on the other hand, are often structured so that the employee receives a set number of shares after remaining with the company for a set period of time.
Do restricted stock units carry voting rights?
No, restricted stock units do not carry voting rights. In order to vote, the employee would need to wait until their restricted stock units are actually paid out and converted into common shares. Similarly, prior to this conversion into common shares, restricted stock units do not pay dividends.