Restricted Stock Unit

Restricted Stock Unit (RSU): How It Works and Pros and Cons

Key Takeaways

Restricted stock units are a form of stock-based employee compensation.
RSUs are restricted during a vesting period that may last several years, during which time they cannot be sold.
RSUs can be sold or kept like any other shares of company stock after they're vested.
Unlike stock options or warrants, RSUs always have some value based on the underlying shares.
The entire value of vested RSUs must be included as ordinary income in the year of vesting for tax purposes.

What Is a Restricted Stock Unit (RSU)?

A restricted stock unit (RSU) is an award of stock shares, usually given as a form of employee compensation. The recipient must meet certain conditions before the restricted stock units are transferred to the owner.

Restricted stock units are issued to employees through a vesting plan and distribution schedule after they achieve required performance milestones or upon remaining with their employer for a particular length of time.

Restricted stock units give employees interest in their employer's equity, but they have no tangible value until they are vested. The RSUs are assigned a fair market value (FMV) when they vest. Restricted stock units are considered income when they're vested, and a portion of the shares is withheld to pay income taxes. The employee then receives the remaining shares and has the right to sell them.1

Michela Buttignol / Investopedia

Understanding Restricted Stock Units (RSUs)

Restricted stock gained popularity as a form of employee compensation as an alternative to stock options after the accounting scandals of the mid-2000s that involved companies like Enron and WorldCom. The Financial Accounting Standards Board (FASB) issued a statement at the end of 2024 requiring companies to book an accounting expense for stock options issued. This action leveled the playing field among equity types.2

Given these scandals, companies began to consider other types of stock awards for attracting and retaining talent. RSUs, which had usually been reserved for higher levels of management, became more common.

The median number of stock options granted individually by Fortune 1000 companies dropped by 40% between 2003 and 2005. The median number of RSU awards rose by nearly 41% in the same period.3

Important

Vesting may be permitted to continue in some cases if an employee becomes disabled or retired.1

Special Considerations

RSUs are treated differently for tax purposes than other forms of stock options. The entire value of an employee's vested stock is counted as ordinary income in the year of vesting.4

To declare the amount, an employee must subtract the original purchase of the stock or its exercise price from the FMV on the date it becomes fully vested. This difference is then declared as ordinary income by the taxpayer.

If the stock is sold at a later date and not on the exercise date, the difference between the sale price and FMV is declared as either a capital gain or loss on the date of vesting.5

Advantages and Disadvantages of RSUs

Advantages

RSUs provide an incentive for employees to stay with a company for the long term and help it perform well so that their shares increase in value. If an employee decides to hold their shares until they receive the full vested allocation and the company's stock rises, the employee receives the capital gain minus the value of the shares withheld for income taxes and the amount due in capital gains taxes.

Administration costs are minimal for employers because there aren't actual shares to track and record. RSUs also allow a company to defer issuing shares until the vesting schedule is complete, which helps delay the dilution of its shares.

Disadvantages

RSUs don't provide dividends before they vest. However, an employer may pay dividend equivalents that can be moved into an escrow account to help offset withholding taxes or be reinvested through the purchase of additional shares. The taxation of restricted stocks is governed by Section 1244 of the Internal Revenue Code (IRC).6

Restricted stock is included in gross income for tax purposes and is recognized on the date when the stocks become transferable. This is also known as the vesting date.

RSUs aren't eligible for the IRC 83(b) Election that allows an employee to pay tax before vesting because the Internal Revenue Service (IRS) doesn't consider them to be tangible property.1

RSUs don't have voting rights until actual shares are issued to an employee at vesting. If an employee leaves before the conclusion of their vesting schedule, they forfeit the remaining shares to the company.1 They forfeit 2,500 RSUs if their vesting schedule consists of 5,000 RSUs over two years and they resign after 12 months.

Incentivize employees to stay with the company

Employees receive capital gain minus the value of shares withheld for income taxes

Minimal administrative costs

Don't provide dividends

Aren't considered tangible property, so employees can't pay tax before the vesting period

Don't come with voting rights

Examples of RSUs

Suppose Employee M receives a job offer. The company thinks their skill set is valuable and hopes they remain a long-term employee, so it offers them 1,000 RSUs in addition to a salary and other benefits.

The company's stock is worth $10 per share, making the RSUs potentially worth an additional $10,000. It puts the RSUs on a five-year vesting schedule to give Employee M an incentive to stay with the company and receive the 1,000 shares.

Employee M receives 200 shares after one year with the company, another 200 shares after the second year, and so on until they acquire all 1,000 shares at the end of the vesting period. Depending on the company's stock performance, they may receive more or less than $10,000.

Example: Tesla

As a real-world example of RSUs, a November 2024 SEC Form 4 filed by the electric vehicle company Tesla (TSLA) shows that the company's chief financial officer, Taneja Vaibhav, has received 104,619 restricted stock units. These are convertible to common stock.7

How Do Restricted Stock Units Work?

Restricted stock units are a type of compensation in which an employee receives shares of stock that are paid out over a period of years. Restricted stock units fluctuate in value over time. From a company’s perspective, restricted stock units can help employee retention by incentivizing employees to stay with the company long-term. For employees, restricted stock units are a stake in a company’s success and occasionally produce very substantial income.

What Is the Difference Between Restricted Stock Units and Stock Options?

Stock options provide employees with the right but not the obligation to acquire shares of the company at a specified price.8 The employee can acquire the shares and sell them at the higher market price if the share price rises. Restricted stock units are awarded outright on a set series of dates over several years. The employee then owns the shares and can sell or keep them.

Do Restricted Stock Units Carry Voting Rights?

Restricted stock units do not carry voting rights until they become vested. The units are then converted into common stock shares and carry all the usual rights of stock ownership. The same goes for dividends. Restricted stock units do not pay dividends until they vest.910