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How to avoid the tax traps of restricted stock units

how to report restricted stock

Bijan Golkar, CEO and senior advisor at FPC Investment Advisory

Mon, 20 Jul '15 | 8:00 AM ET

Restricted stock units are the shiny prize for countless employees in technology and other growing industries.

Henrik Sorensen | Getty Images

Stock options have a tax advantage because they are taxed when you exercise your option. RSUs, however, are taxed at the time they are vested, not when you sell.

As RSUs grew more popular over the past five years or so, we've seen a problem emerging with how they're handled. Too many recipients insist on holding on to their RSUs, even after they vest. In doing so, they are falling into the trap of concentration risk—otherwise known as putting all your eggs in one basket.

In and of themselves, RSUs are a good, solid equity compensation vehicle. An RSU is a grant valued in terms of company stock, but company stock is not issued at the time of the grant. Once the units vest, the company distributes shares, or sometimes cash, equal to the their value. Unlike stock options, which are worthless if share prices dip below the option price, RSUs maintain an intrinsic value unless your company goes out of business.

The challenge with RSUs grows out of how to use them. For most recipients, the correct approach is to

cash the units out once they vest and then use the proceeds to build a diversified investment portfolio.

"Many employees cling to their RSUs because they're afraid of being 'left out.' They're haunted by premonitions of their co-workers getting rich while they sit on the sidelines."

Diversifying your holdings across complementary asset classes allows you to balance risk and reward so that you have the best chance of reaching investment goals without worrying about getting cleaned out. It's standard practice among people who have become financially successful and want to stay that way.

This isn't to say that you shouldn't keep any of your company's stock—far from it. It's exciting to be an owner and not just an employee. The key is to surround that company stock with complementary investments, such as bonds and stocks in other industries.

But too few RSU recipients are doing that; many hold on to their units, at their peril. This is happening because of the misunderstanding of RSUs' tax treatment.

We recently added a client who wanted to use the proceeds from his RSUs to help build a house. The client's plan was to wait a year, sell the vested units and then start building. After a year, he explained, his RSUs would be taxed at the long-term capital gains rate—which is lower than the short-term capital gains rate.

Category: Forex

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