United States: Equity Compensation And The Rise Of Restricted Stock Units

In recent years, equity compensation programs have increasingly been using restricted stock units (RSUs).  A manufacturing company recently made news when it granted RSUs worth millions of dollars to thousands of its employees in connection with its IPO.  Statistics show the trend toward RSUs is widespread.  In a recent survey of 325 companies, 72% reported using RSUs in their long-term incentive compensation programs compared to only 37% ten years earlier.1  At the same time, the prevalence of restricted stock – a similar but less flexible form of equity – decreased significantly, falling to 13% of companies in 2017 from 41% ten years earlier.2

What exactly are RSUs?  How do they differ from restricted stock?  And why are they so popular?  Read on to find out.

What Are RSUs?

RSUs represent a contractual right to receive shares, or a cash payment of equal value, in the future.  This contractual right is unfunded, meaning that it is a mere promise to pay on the part of the issuer.  The contractual nature of RSUs is the primary difference between RSUs and restricted stock.  An award of restricted stock, unlike RSUs, consists of currently issued and outstanding shares that are subject to a risk of forfeiture and restrictions on transferability.  Ultimately, both RSUs and restricted stock represent compensation equal to the value of a share of stock, but the contractual nature of the RSUs permits greater flexibility in the areas of tax planning and capital structure.

As one example of this flexibility, RSUs may be paid in cash or in shares, whereas restricted stock always involves the issuance of shares.  Cash-settled RSUs can allow employees to participate in their employer's equity appreciation without diluting the employer's shareholders or giving the employees voting or other minority shareholder rights.

Whether RSUs are paid in cash or shares affects the accounting treatment of the RSUs.  The details of RSU accounting are beyond the scope of this brief discussion, but, in general, RSUs that can be settled only in shares receive accounting treatment similar to restricted stock.  The fair value of the award, based on the stock price at the time of the grant, is expensed over the service period.  If the RSUs may be settled in cash, on the other hand, then they may be subject to liability accounting, requiring them to be marked to market periodically.  (Consult your accountant to assess the particulars of your company's accounting situation if you have issued RSUs.)

As another example of the flexibility of RSUs, the income taxation of RSUs may be delayed beyond vesting.  The tax event may be delayed until termination of employment, a specified date or a change of control.  The tax treatment of RSUs is discussed further below under How are RSUs Taxed?

Like restricted stock, RSU awards may include vesting requirements or performance conditions that must be satisfied for the award to be earned.  RSUs may include a right to receive payments similar to dividends, known as "dividend equivalent payments," or they may include no dividend rights.  RSUs do not include a right to vote.

How Are RSUs Taxed?

The basic tax treatment of RSUs may be easiest to understand in contrast to the tax treatment of restricted stock.

Restricted stock is considered "property" for income tax purposes.  This means that restricted stock is generally includible in taxable income when it becomes vested or readily transferable.  The one exception is that a recipient of restricted stock can elect to have the value of the stock included as taxable income immediately upon grant by filing an election under Section 83(b) of the Internal Revenue Code (Code) with the IRS within 30 days after grant.

RSUs, in contrast to restricted stock, are not considered property and are subject to normal constructive receipt principles.  Under these principles, RSUs are includible in taxable income when payment of the RSUs is actually or constructively received.  The Section 83(b) election available for restricted stock is not available for RSUs.

The timing of actual or constructive receipt of an RSU, and the time at which it is taxed, depends on the contractual terms of the RSU.  Some RSUs are paid immediately after vesting, in which case the taxation of the RSU is the same as for restricted stock.  Other RSUs, however, are designed to delay the income tax event by deferring payment until an event or date that will occur later than vesting.  As described below, delaying the income tax event for RSUs can be advantageous for the recipient.  However, the FICA tax event, in contrast to the income tax event, for employee holders of RSUs cannot be delayed.  FICA tax is due for RSUs upon vesting, even if payment of the RSUs is delayed.

What Are Some Potential Advantages of RSUs?

Deferral of Income Taxation.  As described above, the income taxation of RSUs can be deferred beyond the vesting date.  Deferring the tax event can allow an employee or director to pay fewer taxes in the short-term.  If the RSU recipient is given the opportunity to choose the timing of the future payment event, moreover, he or she can coordinate the timing of the tax recognition on the RSUs with his or her overall financial plan.  The deferral of the tax event for the RSU recipient may be disadvantageous to the issuer, however, since it also delays the issuer's tax deduction.

Any deferral of RSUs must comply with Section 409A of the Code, which governs all nonqualified deferred compensation, including deferred RSUs.  RSUs that do not comply with Section 409A can be subject to significant adverse tax consequences to the award recipient, including immediate taxation upon vesting, a 20% additional income tax and an interest penalty.

The two primary requirements of Section 409A relate to (1) the timing of payment and (2) the timing of the election to defer payment.  With respect to the timing of payment, Section 409A requires that deferred RSUs be paid (or begin to be paid if installments are elected) on one of the following Section 409A-permitted events:

  • Separation from service
  • Change in control event
  • Specified time or fixed schedule
  • Death
  • Disability
  • Unforeseeable emergency

The payout triggered by the permitted event may occur in a lump sum or in installments, but in general it cannot be accelerated.  For publicly traded companies, there is an additional requirement of a six-month delay on payments to certain specified employees that result from a separation from service.

In addition to these restrictions on the timing of payments, Section 409A includes detailed rules on when the permissible payment event and the form of payment must be selected.  The general rule (subject to many exceptions) is that the time and form of payment for any deferred compensation must be irrevocably elected in the year before the year in which the services to earn the compensation are performed.  For example, for a grant of fully vested RSUs to be made in 2019 by a calendar year company, the initial deferral election rules may require the deferral election to be made by December 31, 2018.  (Note that these are general rules; the actual taxability of RSUs should be assessed in the context of the particular terms of the RSU.)

A deferral election can also be made within the first 30 days following grant, but only with respect to RSUs that will vest at least 12 months after the date of the deferral election.  The fact that RSUs may vest within such 12-month period due to death, disability or a change in control event (as defined in Section 409A) does not preclude the deferral election but, if the RSUs actually vest within the first 12 months, the deferral election cannot be honored.

Section 409A requires that any deferral election be documented in keeping with its rules.  An election to defer RSUs can be documented as part of the RSU award agreement, a separate deferral election form signed by the company and the RSU holder or a nonqualified deferred compensation plan maintained by the company.

Solving the Issue of Taxation Upon Retirement Eligibility.  RSUs can help to address one common problem encountered by issuers who accelerate vesting of restricted stock upon the award holder's retirement.  This type of retirement vesting can inadvertently trigger taxation upon retirement eligibility, rather than actual retirement.  Restricted stock becomes taxable when it is vested for tax purposes, which occurs when the award is no longer subject to a substantial risk of forfeiture.  For example, if an award of restricted stock provides for accelerated vesting upon the award holder's retirement, and defines retirement as any termination of employment after reaching age 65, the IRS considers that award to be vested when the award holder reaches age 65, even if he or she continues working.  Because the award holder can quit at any time and keep the award, it is no longer subject to a substantial risk of forfeiture.  Thus, the restricted stock becomes taxable to the employee even though he or she has not retired, and, depending on the terms of the award, the liquidity of the shares and any insider trading considerations, the employee may not be able to sell shares to raise the funds to cover the taxes.

RSUs can address this issue by providing that the award will not be paid until a fixed date or separation from service, even if it vests before then.  As described above under What Are Some Potential Advantages of RSUs? – Deferral of Income Taxation, choosing separation from service as the payment date may delay income taxation of the RSUs until actual retirement.

Reduction of State Income Taxes RSUs can be used to reduce state income tax liability in some circumstances.  As a general rule, compensation is taxed by the state in which it is earned.  Under the federal source tax rule, however, "retirement income" may be taxed only by the state of which the recipient is a resident or domiciliary.

RSUs that are deferred until separation from service and paid out in 10 or more annual installments are considered retirement income for purposes of this rule.  This suggests some possible tax planning strategies.  As an example, if a recipient of RSUs intends to reside in a low-tax state, such as Florida or Texas, after retirement, he or she may arrange for the RSUs to be taxed in the low-tax state by deferring payment of his or her RSUs until separation from service and choosing payment in 10 annual installments.  (Reference should be made to specific state laws and the terms of the RSU to assess the state-taxation implications of any RSU exercise.)

Easier Satisfaction of Stock Ownership Guideline Requirements RSUs can help executives to satisfy stock ownership requirements.  Many publicly-traded companies have stock ownership guidelines that require their executive officers or directors to hold a number of shares representing a multiple of their compensation.  These requirements are thought to encourage the alignment of the interests of the company's management with the interests of the company's shareholders.

Typically, when restricted stock vests, the award holder surrenders a portion of the shares subject to the award to satisfy the taxes that are due as a result of the vesting and settlement.  This leaves the award holder with only the "net" amount of shares to count toward the stock ownership guidelines.

If deferred RSUs are used instead, the income taxes may not be due immediately, and the total, pre-tax number of shares subject to the RSUs can continue to count toward the award holder's compliance with the ownership guidelines.

***

As described above, the flexibility offered by RSUs explains much of their growing popularity as a component of long-term incentive compensation.  However, RSUs are also subject to complex tax requirements that can be a trap for the unwary.  (And each situation should be carefully reviewed based on its terms.)  RSUs should therefore be designed and administered carefully to ensure that they achieve the desired results.  If you are considering adopting RSUs as part of your compensation strategy or have questions about your existing RSUs, Foley's Employee Benefits and Executive Compensation attorneys would be happy to help.

Footnotes

1 Friedman, Richard, Restricted Stock and Restricted Stock Unit Utilization Today, The Ayco Company, L.P. (2017).

2 Id.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Ostrow Reisin Berk & Abrams
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Ostrow Reisin Berk & Abrams
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions