Welcome to the 6th edition of the Tech Financial Planning (TFP) Newsletter.
I was talking with someone on Linkedin and they were asking about getting RSUs at a private company.
How the heck does that work exactly?
Hello double-trigger RSUs.
In this newsletter we will go over what double-trigger RSUs are, how they differ from “traditional” RSUs, and some important considerations.
TL;DR
Double-trigger RSUs means two events have to occur before they get transferred to you
Once they are transferred to you, they are taxed as income
The two events are typically a time based trigger (ie vesting schedule) and a liquidity event (think IPO or acquisition)
When you receive your double-trigger RSUs, there are a lot of planning considerations to take into account.
The “normal” process with a public company
Restricted Stock Units (RSU) are a type of compensation a company grants its employees.
In general, when your RSUs vest, you acquire full rights and ownership to the value of the units.
This is most often transferred to you in the form of your company’s stock.
Because your company wants to encourage you to stay for a certain amount of time, they will put certain conditions (or restrictions) on the grant.
Typically, this is a time component, more commonly known as a vesting schedule.
This states when some (or all) of your RSUs will vest and become yours on specific dates.
I go into a lot more detail on what happens when your RSUs vest here. But let's take an example:
RSUs granted: 20,000
Vesting Schedule: 25% of your units on the first vest date, then 1/48th of the original grant vests monthly thereafter
First Vest Date: 10/01/2022
Value of a share on First Vest Date: $25
When your RSUs vest, you will have to report compensation income to the IRS. As in most areas of life, the IRS wants a piece of the action, so you will be subject to taxes (federal, state, Social Security and Medicare).
Using this example, we can see how this RSU grant would play out. Aka what happens when they vest, the associated taxes, and if the withholding would be enough to meet the taxes due.
Shares Vested on 10/01/2022: 5,000
Taxable Income (Based on FMV of 5,000 Shares at $25 Each): $125,000
Tax Automatically Withheld at Vest (22%) = $27,500
Your company will often withhold taxes at the 22% tax rate when your RSUs vest. The exception is if your income is greater than $1,000,000, the rate is 37%. Either way, the amount your company withholds might not be enough, depending on your tax bracket.
Once vested, the shares left after your company takes out taxes are deposited into a brokerage account. In our example above, your company will withhold $27,500.
Once vested, the shares remaining post tax are deposited into a brokerage account. In this example, 1,100 shares will be withheld (22% Federal tax rate = $27,500 / FMV per share = $25), and 3,900 shares will be deposited into your account (5,000 vested units – 1,100 withheld to cover taxes).
Why this doesn’t work for private companies
Remember from above, RSUs are taxable once you take ownership. This works well at public companies. If you need to sell your shares to cover the taxes, you can easily do so on the open market.
But at a private company, you don’t have that same ability.
Example - you work at a private company and vested the same 5,000 shares worth $125,000. Even though you can’t sell the shares, you still owe the same amount of taxes.
Cash crunch, meet tax bomb.
And furthermore, you may never be able to sell the shares! Your company may never get acquired or go IPO. So while you have all this company stock, it’s all on paper. It doesn’t actually do much for you.
Enter Double Trigger RSUs
Double trigger simply means two events have to occur before they get transferred to you.
Each plan differs, but here's the typical situation:
🔵Time
Like ”traditional RSUs,” you have to work at the company for a set amount of time before you get the shares
🔵Liquidity event
Think IPO or acquisition.
And importantly, BOTH events have to occur before you can take ownership.
It may seem like a bummer because there are more hurdles for you to get the shares. But it is probably in your best interest. Remember, once you take control of the shares, you will owe taxes (I can’t say it enough).
The two triggers prevent a taxable event from occurring before you have the ability to sell shares of stock to cover the taxes. Otherwise, you might have to come up with the taxes out of pocket. The two triggers make sure you won’t get stuck with a massive tax bill and shares you can’t sell.
Additional Considerations
When you hit double triggers, you could be looking at a huge tax year
One potential issue with double trigger RSUs is you get all the shares at once.
This is because your RSUs will vest over several years. But the liquidity event will (likely) happen in one tax year. Aka when these get transferred, they could jack up your income in one year.
With enough RSUs, you could easily jump several tax brackets. So once they vest, you will have a lot more wealth, but also have to pay a lot more in taxes.
Your company may not withhold enough in taxes
Let’s say that when both triggers hit, you vest $400,000 worth of company shares.
Your company will withhold 22% for taxes (unless you earn over $1M, which bumps up to 37%)
Taxes withheld = $400,000 x 22%
Taxes withheld = $88,000
The problem?
You are in the 35% tax bracket. Which means your actual tax on the vest is much higher
Actual tax = $400,000 x 35%
Actual tax = $140,000
So all things being equal, you would owe an additional $52,000
Additional tax = Actual Tax - Taxes Withheld
Additional tax = $140,000 - $88,000
Additional tax = $52,000
If you don’t plan for this, you have a big surprise coming your way next tax season!
This is why it’s important to know your tax situation so you can plan accordingly. For example, if you know your company isn’t withholding enough and you may owe, it could make sense to make an estimated tax payment when the RSUs vest.
Which is why it can be worth it to work with a CPA or advisor who specializes in RSUs and can help you with your numbers. Everybody’s situation is different, and we are only using hypothetical examples as illustrations, not recommendations.
Keep or sell your vested RSUs?
Now that your RSUs have vested, you have a big decision.
Should you hold onto them or should you sell them?
This is a highly personal decision that can’t be made in a vacuum. Here are some questions to consider:
How much of my net worth do I want to be tied to my company’s performance?
Do my RSUs make me too concentrated in one stock?
If I hold on to my RSUs and the stock tanks, will I still be ok to reach my goals?
What other equity do I have through incentive stock options, nonqualified stock, or employee stock purchase plan?
Do I need cash for other areas of my life - a trip, a remodel, or kid’s college?
As you work through these questions, the answers will better equip you to decide if you should keep the shares or diversify.
If you want to read more about this, I go pretty in depth in my newsletter “Diamond Hands or Diversify”
83b election
This one can be pretty complex.
The 83b election is where you choose to be taxed on your restricted stock when it is granted, not when it vests. The idea (or hope) is that the value of the stock is higher when it vests than when it is granted to you. If this turns out to be true, you will likely have paid less in taxes.
However, there can be downsides too
The first is the opposite of the above - the value of your stock actually decreases from granting to vesting. If this happens, you will probably paid more in taxes than you needed to.
The other is that you are paying taxes that you don’t own yet. If you forfeit the shares prior to vesting, you will have paid taxes on something you never owned. One example where this could play out is lets say, before vesting, you get an incredible job offer you accept. While the potential for the new job may be amazing, you just paid taxes that you didn’t need to.
83(b) elections are tricky and there are big potential risk/reward trade offs. If you are considering this, it probably warrants speaking with a professional.
Exercise more ISOs
If you have incentive stock options (ISOs) that you haven’t exercised, then you may want to exercise and hold a chunk the year your double-trigger RSUs will be taxed may be a great year to exercise and hold your shares.
Because your vested RSUs push your taxable income up, you may have more room to exercise and hold your ISOs without jumping up into the alternative minimum tax (AMT). This is called the AMT crossover point.
Find ways to defer or reduce income
You will probably have a big jump in taxable income the year you get your double-trigger RSUs. Explore ways you can lower your taxable income.
Some ideas:
Max out pre-tax retirement plans (like a 401k).
If you have a spouse, make sure they do too. This will lower your taxable income.
Increase charitable giving
This only makes sense if you are charitably inclined and/or plan on giving to charity. But if you are, explore ideas like bunching donations or a donor advised fund. Done correctly, you can achieve your charitable goals and reduce your income
Defer income
In a big tax year, consider delaying additional income. Candidly, you may not be able to control this. You probably won’t be able to do much about delaying your salary or bonuses.
But you can control things like selling stock or exercising non-qualified stock options (NQSOs).
Putting it all together
Double trigger RSUs can be a huge financial windfall if your company hits it big. But they definitely have tax consequences too.
The good thing is, if you’re proactive you can make the most of your newfound wealth. And possibly bring that tax bill down too!
A final thought
When making any big decisions, make sure you look at all the aspects of your financial life.
For example, don’t let taxes rule the day.
If it makes sense to sell your shares now, even though you might pay higher taxes, do it. A 50% drop in stock price will hurt much worse than paying an extra 10% in taxes.
I hope you are able to use this information to help you plan for your RSUs, your income, and your financial dreams.
If this all feels overwhelming, working with an advisor is a great way to plan for your future.
Whenever you're ready, there are 3 ways I can help you:
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