The Tax (Wo)Man Cometh…

Let me tell you how it will be
There’s one for you, nineteen for me
‘Cause I’m the taxman
Yeah, I’m the taxman

– George Harrison, The Beatles

Last spring, colleague Vince Lee outlined various non-cash-intensive ways companies leverage stocks in many benefits packages, in lieu of larger salaries. These restricted stock units (RSUs) and/or stock options are often part of the offer letter for employees from the upper-echelons of a company through the newbies joining the working world for the first time. This is especially true in the technology sector, where stocks, RSUs and other alternative benefits, like FSA accounts, have become the norm.

Creating a stock incentive plan is a great way for employers to instill a sense of ownership in their employees and align great work with success – stock in a company is literally owning part of the company pie. For many employees, these stock incentives buoy lower salary structures with the promise of large payouts after a given timeframe. As an added bonus, the promise of a vesting schedule can help with employee retention. It would seem like a win-win for all.

What often isn’t adequately communicated – or emphasized – are the tax implications of receiving RSUs. While employers usually withhold a specific amount from an employee’s wages for their estimated tax bracket, when RSUs are factored in, the blended tax rate can be much higher than anticipated. This is where unanticipated challenges, like sticker shock from a large tax bill, can arise. When factoring in a large vesting event, the 22% a company might withhold from wages might not be enough to cover a tax bill. In that unfortunate scenario, the employee taxpayer could have a large, balloon tax payment come April 15.

Having a tax and money management plan in place prior to a large stock event can help the average investor anticipate and sometimes even mitigate large tax bills in a given year. Because the RSUs aren’t taxable until the employee receives them, an employee can have a proactive investment and savings plan ready in the wings to execute in advance of receiving stock. There are decisions that can be made in advance; and estimates on blended tax rates can be calculated to reduce the chance of surprises at the actual vesting event.

RSUs are treated like income when they hit an employee’s account, whether they are liquidated or not. A good tax professional can ensure decisions are made in the best interest of the employee while taking into account their unique tax position. There is often a menu of choices to think about, allowing investors to be in the right mindset prior to receiving their RSUs.  The recipient can decide in advance to liquidate all holdings, pay taxes with the cash, and then diversify their portfolio with the remaining income. There is also the option to hold onto a bulk of the RSUs, liquidating just enough to pay off the taxes due. Or perhaps there is enough cash on hand in a portfolio that nothing will need to be sold.

As always, it’s important to bring in the proper tax professionals when discussing your unique situation. By planning in advance, with decisions made without a lot of excitement or emotion in the moment, you can better manage your budget, stay invested, and continuously save over the long-term. Working in tandem with your tax professional, Coldstream can help guide you through challenging decisions – setting you on a path to financial success for now and years to come. Remember, taxation will always happen – the key is to have a plan in place to execute when the time comes, enabling you to continue on a trajectory towards success over the long-term, no matter which incentives companies have waiting for their employees in the future!