Source: Unsplash
TLDR
- Founders often like to give their employees a sense of ownership. Luckily, there are several options for granting ownership in their startups.
- Two types of vehicles used to grant ownership include RSUs and RSAs. RSUs (or restricted stock units) incentivize your employees to stay with your startup, helping it perform at its best. RSUs also permit you – as the founder – to defer issuing any startup shares until restrictions and vesting are met. This deferral helps you delay any share dilution. Restricted stock awards (or RSAs) are grants of startup stock that are restricted until the share of stock vests, meaning that the restriction expires.
- RSUs, or restricted stock units, are “unsecured, unfunded promises to pay cash or stock in the future and are considered nonqualified deferred compensation,” subject to the Internal Revenue Code. Typically, one RSU represents one stock share. These stock units are generally not taxable when granted; however, they are taxed once the restricted stock units vest. Vesting is a process where the employees become entitled to the granted stock over a period of time, such as three years.
- Upon vesting, RSUs are assigned a fair market value. The Internal Revenue Service considers RSUs fully taxable upon vesting. After a portion of the stock shares is withheld to pay taxes, the employee receives the balance of the shares and may sell them at their discretion.
- Restricted stock awards (or RSAs) are grants of startup stock that are restricted until the share of stock vests, meaning that the restriction expires. When the employee accepts a restricted stock award, they may have to pay your startup a purchases price for the RSA. This restriction period is called the vesting period, which can vary per employer. Further, the restriction (or vesting) may be time-based, such as working for the employer for three years, or performance-based, such as the individual employee hitting certain wales numbers or the employee’s department hitting certain milestones.
- Once an employee satisfies the vesting restrictions, then the employee owns each share outright. At that point, the employee may treat that share of stock just like any other share of stock.
- Regardless of the differences between RSUs and RSAs, offering stock ownership to your employees is highly beneficial to both your team and your startup. With actual employee ownership, you can create a culture of dedicated, happy, productive employees, all directly contributing to the success of your startup.
Founders often like to give their employees a sense of ownership. Luckily, there are several options for granting ownership in their startups. However, when you start digging into the options, it seems more like alphabet soup than compensation and ownership structures.
Two types of vehicles used to grant ownership include RSUs and RSAs. RSUs (or restricted stock units) incentivize your employees to stay with your startup, helping it perform at its best. RSUs also permit you – as the founder – to defer issuing any startup shares until restrictions and vesting are met. This deferral helps you delay any share dilution.
Restricted stock awards (or RSAs) are grants of startup stock that are restricted until the share of stock vests, meaning that the restriction expires.
When employees have a vested interest in your startup, they are often more engaged and willing to promote its culture and values. They also are interested in the company performing above-board, as it directly benefits them. This alone bodes well for your attraction and retention of top talent along with the overall success of your startup.
Despite similar purposes, RSUs and RSAs are different employee compensation structures. In this article, we’ll break down the differences between RSUs and RSAs as well as their benefits.
What Are RSUs?
RSUs, or restricted stock units, are “unsecured, unfunded promises to pay cash or stock in the future and are considered nonqualified deferred compensation,” subject to the Internal Revenue Code.
Typically, one RSU represents one stock share. These stock units are generally not taxable when granted; however, they are taxed once the restricted stock units vest. Vesting is a process where the employees become entitled to the granted stock over a period of time, such as three years.
Upon vesting, RSUs are assigned a fair market value. The Internal Revenue Service considers RSUs fully taxable upon vesting. After a portion of the stock shares is withheld to pay taxes, the employee receives the balance of the shares and may sell them at their discretion.
Restricted stock units do not carry shareholder voting rights. Employees holding RSUs may vote on startup matters once the restrictions on the shares lapse and the RSUs are converted into common shares. Additionally, once vested, employees can receive dividends as well.
The Tax Benefits of RSUs
RSUs enjoy favorable tax treatment. Here are some key benefits for your startup’s employees:
- Taxed Upon Vesting. With RSUs, the stock units aren’t taxed until vesting, not upon grant. The taxable amount is the market value of the shares at vesting. This taxable amount is considered compensation for federal and employment taxes and any state and local taxes.
- Capital Gains Treatment. Once vested, if the employee sells the shares, they will pay capital gains tax on any appreciation over the market value of the shares on the date of vesting.
What Are RSAs?
So, now that we know what RSUs are, what are RSAs? Restricted stock awards (or RSAs) are grants of startup stock that are restricted until the share of stock vests, meaning that the restriction expires. When the employee accepts the restricted stock award, they may have to pay your startup a purchases price for the RSA.
This restriction period is referred to as the vesting period, which can vary per employer. Further, the restriction (or vesting) may be time-based, such as working for the employer for three years, or performance-based, such as the individual employee hitting certain wales numbers or the employee’s department hitting certain milestones.
Once an employee satisfies the vesting restrictions, then the employee owns each share outright. At that point, the employee may treat that share of stock just like any other share of stock.
Instead of shares of stock, the employee may receive the cash equivalent of the stock’s value. The employer will decide if the stock or the cash equivalent is received.
The Tax Benefits of RSAs
Under IRS rules, when an employee receives an RSA, it is not taxed at the time of the award (or grant). Instead, the employee will be taxed when the vesting is satisfied (meaning that the restriction has lapsed).
The employee is taxed on the difference between the fair market value of the stock grant at the time of vesting minus the amount initially paid for the RSA. If the employee receives actual shares (and not cash-equivalents), then the employee’s tax basis equals the amount paid for the RSA plus the amount included in ordinary compensation. Note that the employee’s tax holding period begins when vesting is satisfied.
To satisfy their tax obligation, employees may elect to “net shares,” meaning they will have the appropriate number of shares withheld at vesting to cover their tax obligation. As such, they’ll receive the net balance of the shares after the correct number of shares is withheld.
On the other hand, employees may elect to pay cash to satisfy their tax obligations, meaning that at vesting, they will pay the owed taxes in cash. In this case, the employee will receive the total vested shares.
If the employee decides to sell the shares later, then the employee may be entitled to capital tax treatment, either capital gains or losses, which is much more favorable than ordinary tax treatment.
As further discussed below, the above holds if the employee does not make a Section 83(b) election.
Section 83(b) Election
Under Section 83(b) of the Internal Revenue Code, employees can elect to change the tax treatment of their RSA. When an employee makes a Section 83(b) election, they are electing to include the fair market value of the startup stock at the time of grant minus any amount paid for the shares initially in their taxable income. This holds whether the restrictions are satisfied or not. The RSA will also be subject to required tax withholding.
When employees elect Section 83(b) treatment, they are not subject to income taxation at vesting, no matter the value of the shares at vesting. Additionally, the employees aren’t subject to tax until they sell their shares. Any gains or losses would be treated as capital gains or losses, not ordinary income.
But here’s the catch. If an employee left your startup before fully vesting, they would not be entitled to any refund of any taxes previously paid. Additionally, the employee would not be entitled to any tax loss related to the forfeited stock.
To take advantage of Section 83(b), the employee must file this election with the IRS no later than 30 days after the restricted stock award. Further, the employee must provide you – the startup – with a copy of Section 83(b) election. They also must include a copy of Section 83(b) election with their federal income taxes.
Employees should consult with their accountant or financial advisor on electing a Section 83(b) election.
Comparing RSAs and RSUs
Source: Equvista
Regardless of the differences between RSUs and RSAs, offering stock ownership to your employees is highly beneficial to both your team and your startup. With actual employee ownership, you can create a culture of dedicated, happy, productive employees, all directly contributing to the success of your startup.
We Can Help!
At AbstractOps, we help early-stage founders streamline and automate regulatory and legal ops, HR, and finance so you can focus on what matters most—your business.
If you're looking for help registering your Utah startup, we can get your documentation ready, overall shepherding this process to ensure it's done right. Get in touch with us.
Like our content?
Subscribe to our blog to stay updated on new posts. Our blog covers advice, inspiration, and practical guides for early-stage founders to navigate their startup journeys.
Note: Our content is for general information purposes only. AbstractOps does not provide legal, accounting, or certified expert advice. Consult a lawyer, CPA, or other professional for such services.
Looking for a different state?
Visit our State Registration & Compliance Library to explore how to register a business in a different state.