When people are granted stock options, it’s the same BIG question, every time:
Buy? Or sell?
And when it comes to RSU (or restricted stock units), we almost always tell our clients to sell, and to sell them ASAP.
Like, don’t even hesitate, wait, or take time to “think about it.” Just sell. ????
Reason being, the instant your RSU shares are transferred to you, they’re taxed as ordinary income, even if you don’t cash them out. Typically, your company will sell some of the shares to help cover these taxes, but they almost never sell enough. (Tech companies typically sell enough shares to cover the standard 22% withholding on supplemental wages, but if you’re in a higher tax bracket, you’ll owe more than that 22%.)
So in the end, these RSU end up costing you money, which is why we advise selling them: you can cover the tax cost and have some money in your bank account. Plus, you’re not holding onto shares that may decline in value and become worth less than what you paid taxes on. That’s never fun. ????♂️
Why RSU During an IPO Require Careful Consideration
That said, we do realize that there are times, especially during an IPO, selling right away isn’t the best option… and it may not even be possible.
Usually, when a company goes through an IPO, there’s a waiting period between when the RSU transfer over to the employees, and when those employees are finally allowed to sell them. It’s called a lockout period, and they’re usually six months long.
But even after the six months (or 180 days) is up, there’s sometimes an additional time period you have to wait after the lockout before the next quarterly earnings call when you’re finally allowed to sell. So, you could be looking at having shares for upwards of seven months before you’re finally allowed to do something with them, which is why RSU vested in an IPO require careful consideration.
RSU During a Typical IPO
Chances are, you’ve got double-trigger RSU that you get based on the amount of time you’ve worked for the company when the IPO happens. And when that IPO happens, the number of shares you’ve earned over time vest into your possession. This final vesting is marked by the transfer of shares.
And the instant they transfer, 100% of their value is taxable on the IPO date itself… even if it’s “value” you have that you can’t cash out and liquidate. You still have to pay taxes on it.
To make matters worse, all these shares are taxed at your top income tax bracket. For federal taxes, that can be up to 37%. In some states, it goes as high as 10%.
That’s some serious money owed on money you technically have, but don’t actually have yet, because you have to wait at least six months to sell. And because you have to wait so long, there are three different scenarios that can play out with the value of your shares:
- They go down
- They stay the same
- They go up
And whether or not you sell you shares depends on which of these three scenarios happen.
When to Sell RSU if the Share Price Goes Down
If the value of your shares goes down between the day they vested and they day you’re finally able to sell, sell immediately.
I know it can be tempting to want to hold onto them in hopes that the share value will rise so you can recoup your losses, but it just doesn’t make sense from a tax perspective… not to mention it’s a huge gamble.
Take Lyft for example. At their IPO, each share was worth $72, but it only took one day for that price to start falling. And since then, the prices have gone down by 25%. At the time of writing, shares are only worth about $54 each.
Assuming the value stays where it’s at and doesn’t go down any more before the lockout period expires, the employees are still looking at some terrible capital losses.
Let’s look at the math:
They have to pay taxes on a $72 tax basis based on the price that the IPO happened and the shares vested. However, when they sell, they’ll only get $54 each. $72 – $54 = an $18 per share loss.
And yes, you are able to report capital losses on your taxes, but it’s not pretty. ????
According to tax law, capital losses can ONLY be used to offset capital gains (assuming you have them in other investments, you may not)… or to reduce your ordinary income by a maximum of $3,000 per year… which is not much compared to what some IPO & RSU situations result in.
In this situation, it’s best to sell as soon as you get into your first available trading window and not wait for the day when the price might come back up.
Twitter, for example, had one of the most successful IPOs in the tech world. When it IPO’ed on November 7, 2013, it was at $26 per share and climbed as high as $69 per share during the lockout period.
However, when the lockout ended, the value had fluctuated back down to just $39 per share, and dropped below the original IPO price in August 2015. It stayed that way for TWO AND A HALF YEARS, below the original IPO price, until February 2018.
So if the share value goes down, go ahead and sell so you don’t get stuck with incredibly low-value shares that are just costing you more money than they’re worth. Chances are, you’ll still be making some money anyway.
Then, determine what you’ll do about paying the taxes you owe on them.
If you have capital gains from other investments in your portfolio you can use the losses to harvest those.
If not, can you create capital gains by selling some of your ISO shares?
If you’ve exercised ISOs in the past, you may have access to a large, unrealized capital gain even if the price has dropped. If that’s the case, consider selling all of your RSU shares with losses, and using those losses to sell some of your ISO shares to avoid a capital gains tax.
When to Sell RSU if the Share Price Stays the Same
Yes, sell. Again.
I know I might be starting to sound like a sell-happy, broken record here ????️, but I’m serious.
There’s no taxed-based reason to hold onto these shares if the sell price during your first trade window is similar to the IPO price.
By selling now, you’ll free up cash to pay the taxes you owe in April, and you’ll avoid the possibility of a capital loss if the price falls.
When to Sell RSU if the Share Price Goes Up
Obviously, you can sell if you want to take advantage of the capital gain you get.
For example, when Zoom IPO’ed this year, it was at $36 per share… and right now, the price has gone up to $89 each. A 147% increase. ???? That’s pretty significant.
However, if the price goes up during your lockout period, you may want to consider holding. For one, the potential benefit of waiting grows as the price goes up.
If you worked for Zoom and decided to sell after the lockout at the $89 price tag, you’d pay ordinary income tax on an additional $53 per share. ($89 sell price – $36 cost basis = $53 additional taxed as ordinary income.)
Plus, if you’ve already waited six months, that means you’re only six more months away from the one-year mark, after which you qualify for your profits being taxed as long-term capital gains instead of ordinary income.
For example, if you sold after the lockout and you were in the top income bracket, you’d pay 37% on that $53, meaning you only get to keep $33.39 per share.
But if you waited for the one-year period, you’d be taxed at the top long-term capital gain rate, which is only 23.89%, meaning you get to keep $40.34 per share.
You can calculate your break-even price, and decide if the tax savings is worth it for you… and then decide whether to sell now or later.
When to Sell RSU With Direct Listing IPOs
Direct listing IPOs are different from traditional IPOs, in that you might not be held to a six-month lockout period if your company chooses this route. Spotify decided to do this, and Slack will be next.
When this happens, you can choose to sell enough shares to cover taxes when they’re transferred to you, or you can do a same-day sale where all of your RSU are sold immediately when they’re transferred to you on the date of the direct listing.
Here though, you won’t have a waiting period to know how the stock price values will perform over a six-month period, so you’ll have to use your best, educated guess and intuition.
Just remember though: there’s no tax-based reason to hold onto the shares instead of selling them, and if you do decide to do a sell-to-cover, the withholdings probably won’t be enough to cover your taxes, because they’ll only be 22%.
In Conclusion: Don’t be Afraid to Sell
It seems like when we’re all scared to sell off something that’s given to us… even if it’s just RSU from our company as another form of compensation for working there.
And while it might not be the kindest thing in the world to do to immediately sell a sweater your grandma gives you, there’s nothing wrong or rude about selling your RSU the instant you have the chance. They’re given to you by your company as a wealth incentive & a thank-you for doing a good job… sort of like a bonus.
And you wouldn’t feel guilty about spending or using your bonus money right away, right? So don’t be scared to use your new, added RSU wealth for the same reason!If you’d like some help deciding what to do with your RSU in your situation, book a call with one of our advisors.