What is RSU?
Restricted stock units or RSUs are also known as restricted securities and they are essentially similar to employee stock options with the most notable difference being that RSUs are stock units that are restricted and can only be unlocked after certain pre-specified goals are achieved, unlike employee stock option which don’t have any conditions that need to be met. So basically it is you being handed out shares of the company that don’t carry a value as of now but will do so in the foreseeable future that is when they are fully transferable. Usually, RSUs are unlocked on meeting conditions like completing a certain period being employed by a company, meeting certain goals or financial targets, etc. An RSU can be restricted from being sold in the initial stages of the company being founded and developed. RSU can be unlocked if the company is sold to a third party and you may or may not be fired within a given time frame after the company changes ownership, however, in both cases the RSUs get unlocked. If you are fired it becomes a double trigger and if you aren’t then it is called a single trigger. You may also be forced to hold an RSU in case an IPO is initiated. You might be asked to hold the stock for the mentioned time so that the company share prices aren’t destabilized. Now that we understand what is meant by RSUs it is time to understand how to avoid paying taxes on RSU.
How to avoid paying Taxes on RSU? A Guide
We all know how the government and taxes can be, which is why we also know that one way or the other any and every income of yours is going to be targeted and taxed no matter what. RSUs are also not safe from being taxed no matter how much you try to avoid paying taxes on them. In fact, you might have to pay taxes on RSU twice and that can be even more painful since the income earned is once but the money paid for it is twice. First, you have the vesting period to consider. This is when your restricted stock units are becoming unrestricted as you are slowly meeting the requirements to unlock them. Once your stock becomes unrestricted they attract taxes on the fair market price of the stock at the given time which you are now to pay as it is an income and that subjects them to income tax. This is only the first of the two times that you pay taxes on the RSUs. You can look all around for how to avoid paying taxes on RSU but you will find no way to avoid them. However, the second tax that you have to pay on RSU is the capital gains tax and that is the one you can avoid in case you don’t gain any value on the stocks. However, it is again a losing situation for you if your stocks didn’t grow in value. Even in capital gains tax, you have further two options of paying tax depending on the time that you have held your stocks for. Let’s say you hold the stocks given to you for a short period like less than a year in that case you will see yourself paying 15% tax on the amount of gains made, however, any tax paid earlier is discounted from this. On holding these stocks for the long term you can avoid paying capital gains tax if they are listed on the stock exchange. However, if the stocks aren’t listed on the stock market then the capital gain will be viewed as an income and will be taxed as per your tax slab for short-term gains or at 20% in case of long-term gains with indexation factored in as well. Now you know how to avoid paying taxes on RSU, let us learn about RSU tax calculator.
RSU Tax Calculator
So you see how you have to pay two taxes on RSU, but you also need to understand that if you work or earn in a nation that hasn’t signed a DTAA with India then you might have to pay taxes in two countries for one income. DTAA stands for double taxation avoidance agreement which India has signed with 85 countries. As per DTAA, you are safeguarded from posting tax twice on a single income. However, you still have two taxes to pay. To find out the tax owed on an RSU you can use the RSU tax calculator or just the formula for income tax and capital gains tax. When the vesting of RSUs is done you are charged tax on the amount as a part of your income and then when you sell the stocks they are now subject to a long-term or short-term capital gains tax. So having an idea of your tax slab percentage and the rates charged for short or long-term capital gains should be enough to help you work out your tax amount. So let’s say you were given 5,000 shares with each of them being valued at 100 rupees as a part of the RSU scheme. So that brings the total value of your holding to 5,00,000 rupees which also becomes the income amount that is now to be used to calculate the income tax. So depending on your tax slab, this 5 lakh rupees will be taxed and that is where one part of your taxation will come to an end. Now let’s say you sell these shares for 7 lakh rupees which means you earned a profit of 2 lakh rupees. Now you know how to avoid paying taxes on RSU if they are long-term capital gains as well as listed stocks on the stock market but if not then the 2 lakh rupee profit will be charged at the rate of tax slab or as per the short-term gain percent whichever may be applicable. So even by using a simple calculator, you could find out the RSU tax that you owe to the government. Now you know about RSU tax calculator. Also Read: Tax on Dividend Income: What You Should Know
RSU Tax Strategy
As we saw above, there is no answer to how to avoid paying taxes on RSU nor can they be deferred but that doesn’t mean that there are no strategies to effectively and smartly deal with them. There are a few ways that can help you make sure you are planning proactively for the taxes or are delaying the capital gains tax for some time to save money till that period.
Tax Deferring
When you contribute funds to your employer’s 401(k) account made for you or an Individual retirement account you get a tax benefit for the same since contributing money to these tax accounts brings you relief on your taxable income for the given year. Now you may be holding RSUs but might not be cashing them out to avoid paying capital gains tax, however, if you sell these RSUs and transfer the sum of 30,000 dollars to your 401(k) account or 7,500 dollars to your IRA account and that way you can offset the tax bill.
Bunching
Every income tax filing that happens has a lot of deductions that can be used here and there and get you deductions. You need to itemize the deductions on various qualifying expenditures like mortgage interest, medical expenses, charity, state, and local taxes as well as real estate taxes and more. So let’s say that you have made a handsome amount of money through RSUs in a year and are into charity and donations, then you should consider paying a bigger sum in advance rather than making small payments each year. Or if your medical costs can exceed 10% of your gross income then you should make sure to let that happen by not deferring the payment. These expenditures can be set off as deductions which means that they qualify for tax deductions and can help you save money. This way you can deduct the taxable income and make it smaller than what it originally would be, making this a perfect RSU tax strategy.
Donor Advised Funds
Now let’s say you can pay the charity up front but opt against it and instead wish to pay year on year basis. In that case how to avoid paying taxes on RSU? Here comes in Donor Advised Funds. You need to open a charitable fund in your name and make contributions to it which gets you an income deduction. RSU income can be used to fund DAF and this way you can also avoid paying capital gains tax on the donated portion. However, you need to have the ability to pay to the fund and it is also irreversible as any contributions made need to be given to charity and can’t be recovered by you.
Hedging
Unlike the other three options, this one is a future-based option and does not help save money on the current taxable amount. Here you would be required to keep holding the RSU for now till it’s more favorable to sell them. So here you hedge your RSU position using the covered call or collar strategy where you buy call or put options and enter a tradeoff. And so when the time is right you can then sell your RSUs as you please.
RSU withhold shares to cover taxes
You might still be wondering how to avoid paying taxes on RSU altogether and if there is some loophole out there or a way by which you can be saved from paying taxes on them. But let us make that very clear to you, there is no way you are not paying taxes on them no matter what tactic you deploy. We ourselves have shared a few strategies to defer or reduce the tax paying period or amount and that’s about how good it gets. You might think how are we sure that RSUs cannot be hidden from being taxed, the answer to that is coming up. The thing is that your company is in a position where the onus is on them to deduct the tax on vested RSUs. And when the giver themselves are the takers then how do you expect to escape out unguarded? There are a few ways that they can take care of the matter and ensure that you don’t receive the gross RSU but rather the net RSU or amount. The method varies from one trading company to another but you are only given the options that your company offers. The sell-to-cover is the most commonly used practice in the taxation of RSUs. Here the tax is deducted at source as per the income slab you fit in and so if you are to 25% in taxes then the company will sell 25 of the 100 shares owned by you and pay the tax to the government while the remaining 75 shares will be kept in your account for when you wish to sell them. This is just one of the RSU withhold shares to cover taxes method employed but there are more. In the same-day sale method, all vested RSUs are sold immediately and the amount received is used to pay off the taxes. The remaining money is then wired to the accounts of the employees. Another common method is the cash exercise option where you are allowed to pay the tax and your shares aren’t held by the company. However, your brokerage account needs to have the money that needs to be paid. And so this is why no matter how much you brainstorm about how to avoid paying taxes on RSU it will be no good because right at the source your dreams have been shredded.
Taxation of RSU in India
Taxation of RSU in India is simple as we have seen above. Unless you are making money that is taxable in two countries there is not much to worry about. You just need to know your tax slab and the necessary tax percentages that are chargeable on the category that your RSU or money from RSU falls into. First, there is an income tax and then there is a capital gains tax which can be a long-term tax or a short-term tax or in case your luck works out then it might not even be there. There are various stages to an RSU like acquiring them then there is the vesting period and then after they have been vested you can still opt to hold them or sell them immediately or even go on and keep them for a considerable period of time before you sell them. Now all of these situations carry different taxes rates or charges that you are subject to and having a knowledge of the tax rates can help you calculate and plan in advance on how to go about paying them. The first stage is the acquiring stage which is the only stage where you might not have to think of how to avoid paying taxes on RSU as there isn’t one levied on you at this stage. It is the only stage that is free of tax as from here on the tax comes into the picture. Once the RSU has been vested they now qualify as an income that you have earned and any income earned is subject to an income tax and so be ready to pay up when the time comes. Now after the RSU has been vested it is time for them to be sold or held for some period before they are eventually sold. Now if the sale is immediate or happens within a year or two of getting the RSU then they are taxed as per the applicable tax slab that you fit in while the sale value is added to the income tax amount. And if you keep the RSUs for a long time that is more than 2 years and then when you do finally decide to sell them you are bound to pay taxes as per long-term gain provision and indexation is also factored in. Also Read: How to avoid Capital Gains tax on Stocks? A Guide
Pros and Cons of RSUs
Having discussed everything from how to avoid paying taxes on RSU to how taxation works on them in India we have covered pretty much everything except the advantages and disadvantages offered by them and so let’s complete the formalities. An RSU might require you to be a part of the organization for a said amount of time as a criterion for it to complete vesting and that provides you stability and encouragement to stay working at a fixed organization for a longer period. Getting an RSU might also act as a booster to your morale and may make your work with higher efficiency. RSUs can bring in good money if held for a long time even if you have paid taxes on them. RSUs are simple to understand and their taxing is also simple and easy. As opposed to a cash bonus RSU can see its value go up as the company climbs ladders of success and that should work in your favor. Stock Options come at a certain strike price but RSUs always have some kind of value after vesting and so in comparison, you are getting something better which can be said to be an upgrade. RSUs don’t get you any dividends as they aren’t the real stock of the company and that might be an issue with them. While RSUs forcing you to work at a company for a fixed time to meet vesting requirements can be a good thing it can also be a bad thing as you are forced to work at a company that might no longer be a good place to work at and leaving midway can lead to forfeiting the RSU. No matter what RSU tax strategy you use, the shares don’t belong to you until the vesting period is over and so it could be a long time before the deal gets materialized. If you work for a private company then the wait can go on for an even longer period as transfer or sale of RSU is only possible after the company faces a liquidity event. While RSUs can rise in value they can also see a decline and this is where cash bonuses are better since they don’t change in value. So with that, we now have all bases covered on RSUs. We started by looking at how to avoid paying taxes on RSU which is true only in part. However, by using a combination of an RSU tax calculator and a good RSU tax strategy you might be able to come up with solutions to work out a lower taxable amount or defer the payment to a later and more suitable date. You also now know that the company that gives RSU withhold shares to cover taxes and so avoiding them is next to impossible, that is why we have also covered taxation of RSU in India which should come in handy the next time your company is giving away those or when you are about to sell off your existing holdings.
