Don’t Let Clients Get Burned by Restricted Stock Units at Tax Time
There’s often a gap between what a stock award looks like on paper and what it means after withholding and taxes.
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Cash is king, sure, but restricted stock units are also royal in their own regard.
Company stock can represent more than half of total compensation for top executives at publicly traded companies, per data from Northern Trust. Without a plan in place, it can create significant concentration issues and a serious liquidity crunch at tax time. The best outcomes require executives (and their advisors) to look at it as part of the entire household balance sheet, rather than treating salary, equity awards, deferred comp and taxes as separate silos.
“Managing different forms of compensation as part of the broader plan for our corporate executive clients is a mix of art and science,” said Robert Westley, senior vice president and wealth advisor at Northern Trust. “You have to balance a lot of moving pieces.”
Stock Comp Fundamentals
The tax issues involved in equity compensation are fundamentally about when the stock becomes taxable and whether the client has the liquidity needed to pay the bill.
Consider an executive with 10,000 restricted stock units with a three-year vesting period. Generally, taxation occurs only when the stock units vest and the shares are delivered. If the stock stood at $150, for example, the executive would then own $1.5 million of stock. Crucially, however, that $1.5 million is taxable compensation, not a capital gain, meaning the client could face a tax obligation of several hundreds of thousands of dollars.
“The problem is that the executive received stock, not cash,” Westley said. While companies often facilitate automatic “sell-to-cover” or net-share withholding at vesting, executives can face additional constraints when they want to sell shares beyond those needed to satisfy withholding. These include:
- Trading windows and blackout periods.
- Insider-trading restrictions.
- Company stock ownership requirements.
“Even if a stock can technically be sold, there could be reputational concerns about selling,” Westley said. “If the person is really high up in the company, their choice to sell a significant number of shares can spark negative speculation from analysts. They may need to find another source of liquidity.”
None the Richer. A particularly challenging situation arises if shares vest and then fall in value. For example, if an executive recognizes $1 million of equity compensation income in June but the stock falls 30% by December, the subsequent $300,000 decline generally becomes a capital loss, but it isn’t recognized as an ordinary income adjustment. If the executive eventually sells to cover a tax liability, their after-tax wealth can actually fall.
