Taxation of Restricted Stock Units

I have been receiving a lot of questions about RSUs. I think this is because a lot of large public tech companies use RSUs rather than stock options.

For a variety of reasons, RSUs do not translate well to the startup company arena. I discuss this below. But first, let’s summarize some key facts about RSUs. 

What Is a Restricted Stock Unit?

An RSU is a contractual promise on the part of a company to deliver shares to a service provider after the fulfillment of vesting conditions.

For example, a service provider might get 100 RSUs, vesting after 1 year of service. After 1 year, the company would issue 100 shares of stock in fulfillment or settlement of the RSU.

Can an 83(b) Election Be Made On the Receipt of an RSU?

An 83(b) election cannot be made on the receipt of an RSU. The reason for this is because the RSU is merely a promise on the part of a company to issue stock later upon the fulfillment of vesting conditions. An RSU is not an award of stock.

Is an RSU Taxable Upon Receipt?

An RSU is not taxable upon receipt because all that is given is a promise on the part of a company to deliver shares later if vesting conditions are met.

Is an RSU Taxable Upon Vesting?

When an RSU vests and shares are delivered, the shares are taxable. The value of the shares at that time is taxed just like ordinary income wages or salary or independent contractor payments.

How Does an RSU Compare to Other Types of Awards?

An RSU is different from a stock option and a restricted stock award in a number of key respects.

I have summarized the differences in the table below. As you can see from the table below, for early stage companies, options or restricted stock is typically better than an RSU.

Table Summarizing Some of the Differences in Award Types

Restricted Stock Units Restricted Stock Awards Stock Options
Taxation at Grant? No Yes, if vested or an 83(b) election is made No, as long as priced at fair market value
Taxation Upon Vesting? Yes, because usually shares are delivered upon vesting; and there is ordinary income at that time at the then value of the shares. Yes, if subject to vesting and no 83(b) election was made No, as long as priced at fair market value
Taxation Upon Settlement or Exercise? Yes, ordinary income at that time at the then value of the shares. No concept of exercise with a restricted stock award Yes, but exact consequences depend on whether an ISO or NQO

What Don’t RSUs Fit In Early Stage Companies Very Well?

  • An early stage company’s shares are not liquid. When you receive them, you can’t sell shares to pay the tax. This is not the case for public companies.
  • Early stage company’s frequently do not have the cash reserves to help their employees pay their taxes. Large public companies will sometimes withhold shares from employees on the vesting of an RSU to satisfy the tax withholding. This only works though if the company has the cash to pay the taxes.
  • For private companies that anticipate an IPO in the foreseeable future, RSUs can make sense. But this is not the case for a lot of early stage companies, where restricted stock awards or options are going to make the most sense.

Generalized Warning/Cautionary Statement

It is always advisable to consult with tax advisors and lawyers in evaluating the particulars of equity incentive award documents. Award documents vary widely in the wild, especially RSU award documents. And this blog post has made simplifying assumptions that may not apply in your particular situation. Good luck and have fun out there!

State Equity Crowdfunding vs. Rule 506

In Washington State, we will soon have equity crowdfunding. This is going to be exciting. Founders will have an entirely new fundraising choice available to them.

State Equity Crowdfunding vs. Rule 506

Historically the only real choice available to small, private companies that wanted to raise money through the sale of securities was Rule 506(b) under Regulation D.

Why 506(b) Is So Great

506(b) is the mainstay of early stage company financing for a number of reasons.

  • Companies can raise an unlimited amount of money.
  • There is no filing required to be made with the SEC or state securities regulators before the first sale of securities.
  • State securities regulators can require the filing of a Form D and the payment of a fee within 15 days of the first sale, but cannot condition the offering on their pre-review of the merits of the offering.
  • If only accredited investors invest, there is no specific disclosure requirements.
  • Companies have to have a reasonable belief that investors are accredited, but they do not have to ask for an investor’s tax returns or personal financial statements to verify that belief.
  • No general solicitation or general advertising is allowed.
  • Up to 35 non-accredited investors are allowed, but if even 1 non-accredited investor invests then there are very specific, very robust disclosure requirements. This is why most companies limit their offerings to all accredited investors.

The New Thing: Rule 506(c) Offerings

The JOBS Act opened up a new avenue for private company financings, Rule 506(c). Rule 506(c) offerings are different from Rule 506(b) offerings in the following ways:

  • Companies can generally solicit or generally advertise their offerings.
  • Only accredited investors can invest.
  • Companies cannot rely on investor certifications that they are accredited. Instead, they have to seek additional verification of such status by asking for tax returns or financial statements. Or have a third party do so.

Primarily because of the additional verification requirement, Rule 506(c) has not caught on as much as some thought it would. There is also another reason 506(c) has not caught on: The SEC has proposed very onerous, draconian regulations that could apply to Rule 506(c) offerings in the future.

If you want to hear a contrary view on why 506(c) hasn’t caught on, read this speech by Keith F. Higgins, the Director of the SEC’s Division of Corporation Finance.

State-Level Equity Crowdfunding

State-level equity crowdfunding is the new new thing. It is currently only available in a few states, and each state’s laws are very different. Washington State will soon have equity crowdfunding. Once it does, founders in Washington State will have a new choice available to them.

Washington State equity crowdfunding will allow the following:

  • Companies will be able to raise up to $1M during any 12 month period.
  • From both accredited and non-accredited investors.
  • There are individual investor limitations that track the federal crowdfunding law.
  • For so long as the crowdfunding securities are outstanding, the company will have to make public disclosures about its executive officer and director compensation.
  • Before a company can equity crowdfund, they will have to file a Crowdfunding Form with the state and get approved to proceed.
  • Companies have to be incorporated or organized in Washington.
  • Investors have to be from Washington State.
  • There are advertisement restrictions.

A Table Showing the Differences

The below table shows some of the key differences between the different offering types.

506(b) 506(c) Washington Crowdfunding
Size of Offering Limit No limit No limit $1M during any 12 months
Individual investor limitations No No Yes; the limitations track the federal crowdfunding law
Pre-closing filing requirements No No (but see the proposed regulations) Yes, offering must be approved prior to the start of the offering
Limited to accredited investors No (but as a practical matter yes) Yes No
Public disclosure requirements Form D Form D Quarterly reporting far more extensive than Form D disclosures
Investor Verification Requirements Reasonable belief Additional verification requirements Reasonable belief standard; WAC 460-99C-150
Investor residency requirements No No Yes; investors must be from Washington State
Escrow Requirement? No No Yes
Minimum Target Offering Requirement? No No Yes
Advertising Allowed? No Yes Not really; subject to limitations
Incorporation or Organization Requirement? No No Yes, company must be incorporated or organized in Washington

For a discussion of the problems with advertising intrastate equity crowdfunding offerings, see this article.

What Should You Do?

Most companies will continue to follow the 506(b) path. The big drawback to 506(b) is that it is in effect limited to accredited investors only. The crowdfunding path allows non-accredited investors, but also has other significant limitations.

RSUs vs. Restricted Stock vs. Stock Options

For an early stage or startup company, which type of equity incentive is better? An RSU or a restricted stock award or a stock option?

equity compensation

RSUs vs. Restricted Stock vs. Stock Options

The short answer is–RSUs are generally not a good idea in the early stage or startup company setting, and whether an option is better than a restricted stock award depends on two things:

  1. the fair market value of the company’s common stock, and
  2. the ability of the award recipient to bear tax today.

Why RSUs Generally Don’t Make Sense for Early Stage Companies

RSUs generally don’t make sense for early stage companies because they are less advantageous than either restricted stock awards or options, but entail a lot more complexity. In startupland, complexity should be avoided to keep legal and accounting costs down.

RSUs are less advantageous than options or restricted stock awards because of how RSUs work. With an RSU, the award recipient doesn’t receive stock or an option to purchase stock. Instead, the recipient receives a unit award. Not stock, but a unit award. No 83(b) election can be made on the receipt of a unit award because an 83(b) election can only be made on the receipt of actual shares of stock. (Just like you can’t make an 83(b) election on the receipt of an option; you can only make the election on the receipt of actual shares.)

There is no tax due upon the receipt of an RSU, which is good, but here is the problem: The unit award will be subject to vesting. When the units vest, the company will deliver the shares of stock to the award recipient. The shares of stock delivered will be taxable as ordinary income then, at that time. And at that time the value of the shares may have gone up substantially since when the RSU was awarded, and the taxes due may be significantly more than the recipient expected, or that the recipient can bear.

This is why in an early stage company, award recipients typically either prefer stock options or restricted stock awards.

RSUs can and do make a lot of sense for more mature companies, especially public companies that can provide award recipients with the ability to immediately sell shares to fund tax liabilities. Or companies that have significant cash reserves and that can help employees fund their taxes. Or companies that have a public offering planned in the reasonably foreseeable future. But in startup land, this is rarely the case.

The Taxation of Stock Options

Stock options are not taxable upon receipt, as long as they are priced at fair market value. This is nice, because the recipient can defer tax until option exercise. Stock options are also not taxable upon vesting. Another nice feature of stock options.

A stock option is taxable at exercise–but the tax consequences will depend on whether the option was a nonstatutory or non-qualified stock option or an incentive stock option. I have written about this extensively in other blog posts. See, for example, ISOs vs. NQOs. See also, Top 6 Reasons to Grant NQOs over ISOs.

The timing of stock option exercise is typically under the control of the optionee, post-vesting. Options are good for this reason–the optionee can generally control the incidence of the taxable event–which is exercise. Regardless of whether the option is an NQO or an ISO, the capital gains holding period does not start until exercise.

The Taxation of Restricted Stock Awards

Restricted stock awards can either be taxable upon receipt by making an 83(b) election or will be taxable upon vesting if no 83(b) election is made. Both situations are problematic. Sometimes an award recipient can’t afford the tax due if they make an 83(b) election upon receipt of the shares. And sometimes an award recipient can’t afford the tax due when the shares vest.

Thus, when considering whether to grant someone a stock award or a stock option, it is a good idea for companies to consider the ability of the award recipient to pay taxes today. If the value of the company’s stock is very low–such that a stock award will not give rise to that much tax today–stock awards can be nice because the recipient can receive stock, and start their capital gain holding period immedately.

What Should You Do?

One thing you could do is lobby your Congressional representatives to change the law.

As Fred Wilson said, and I agree with him:

“I do not believe there is an optimal way to issue employee equity at this time. Each of the three choices; options, restricted stock, and RSUs, has benefits and detriments.”

What could Congress do? As Dan Lear and I wrote, they could make the transfer of stock not taxable in the employer/employee context for illiquid private company stock.

Table Summarizing Some of the Differences in Award Types

Restricted Stock Units Restricted Stock Awards Stock Options
Taxation at Grant? No Yes, if vested or an 83(b) election is made No, as long as priced at fair market value
Taxation Upon Vesting? Yes, because usually shares are delivered upon vesting; and there is ordinary income at that time at the then value of the shares. Yes, if subject to vesting and no 83(b) election was made No, as long as priced at fair market value
Taxation Upon Settlement or Exercise? Yes, ordinary income at that time at the then value of the shares. No concept of exercise with a restricted stock award Yes, but exact consequences depend on whether an ISO or NQO

Generalized Warning/Cautionary Statement

It is always advisable to consult with tax advisors and lawyers in evaluating the particulars of equity incentive award documents. Award documents vary widely in the wild, especially RSU award documents. And this blog post has made simplifying assumptions that may not apply in your particular situation. Good luck and have fun out there!

Startup Public Policy

Startup Public Policy is important. Too important not to pay attention to. Too important not to be an active advocate. Politics might sound like a drag, but what Congress does really affects us–both on the good side and the bad side. You can’t sit on the sidelines and hope for the best. You have to be an active participant in the process.

The happy news is that it is possible to have a positive impact on startup public policy without a tremendous amount of effort.

And my friend Dan Lear and I are here to help you, at least in part.

We put the attached letter together for you. When your Congressional representatives ask what they can do to help startups, you can give them the attached letter. And you can also deploy it now by printing it, signing it, and mailing it to your Congressional representative.

Dan and I would appreciate your thoughts on the content. Thank you.


From Startups Across America

Dear Congress:

The Great Recession is slowly fading from memory but America still needs jobs. Research has shown that small businesses and startups (fast growing small businesses) are the source of almost all of America’s new jobs. Unfortunately, existing federal law and regulation makes entrepreneurs’ efforts to found, run, and grow startups harder not easier.

Starting a company is hard. Entrepreneurs must identify a good idea, capitalize on it faster and more efficiently than competitors, find money to grow the business rapidly, develop and demonstrate competence in a wide range of disciplines: finance, leadership, management, product development, operations, law, etc . . . . and do many other things as well (even sweep the floor).

Aside from the normal difficulties of starting a business, additional and needless legal and regulatory hurdles hamper entrepreneurs’ ability to found, build and scale these important job engines.

This is where you can help!

Through some straightforward statutory modifications and regulatory changes in a few important areas: (1) Angel Investment, (2) Crowdfunding, (3) General Solicitation, and (4) Tax, you can significantly improve the entrepreneurship landscape and make it even easier for startups and entrepreneurs to create jobs.

Regarding Angel Investment:

Preserve Broad Access to Angel Investment. Many of America’s best-known companies got their start or early support through an early stage investment strategy known as “angel investment.” Angel investors provide smaller amounts of business investment to companies in early stages to help the company with capital demands and to jumpstart growth. Though angel investing can be risky it is a crucial part of the unique and dynamic US startup ecosystem. But the SEC might make disastrous changes to regulations governing angel investing.

Angel investors must be “accredited” by the SEC. In 1982, the SEC set rules defining who qualified as an “accredited” investor. Now the SEC is considering updating the financial thresholds in a way that would disqualify more than half of the population that currently qualifies as “accredited.”

This would significantly reduce the amount of capital available for angel investment and, in so doing, almost certainly reduce the amount of angel investments made.

What you can do: Please pass a law or instruct the SEC to not increase the financial thresholds to be an accredited investor. The US startup ecosystem needs broad access to angel investment; keeping the accredited investor thresholds low will insure this.

Reduce Regulatory Restrictions on Angel Investments. Beyond retaining the current regulations for angel investment you can also make angel investment easier by making the following changes.

What you can do: Please:

  • Reduce, don’t increase, the financial thresholds to qualify as an accredited investor.
  • Repeal Section 413 of the Dodd-Frank Act, which precludes counting home equity toward the $1M net worth “accredited investor” test.
  • Allow “sophisticated” investors to invest despite not meeting the financial thresholds.
  • Allow individuals to invest up to 5% of their net worth or annual income per year in startups despite not otherwise meeting the “accredited investor” thresholds.

Regarding Crowdfunding:

Allow Intrastate Crowdfunding. States across the country are passing intrastate crowdfunding laws that empower local communities to build their own local startup ecosystems and small businesses instead of looking to Wall Street or Silicon Valley for resources. These state laws are not subject to the federal crowdfunding law because the companies raising the money are incorporated in those states and raising money solely from investors in those states, in accordance with the specific exemption from federal law for intrastate offerings that Congress enacted in the Securities Act of 1933.

However, the SEC has recently issued interpretive guidance on the intrastate exemption that says that if the company uses the internet to promote/discuss its offering then the offering is not an intrastate offering even if a company is incorporated in a particular state and all investors are in that state.

This is nonsense and it needs to be corrected. Besides the fact that it’s nearly impossible not to use the internet to communicate any fundraising or community organizing event, for many if not most of the entrepreneurs seeking to raise money under state crowdfunding laws, the internet represents the ideal tool to communicate a fundraising effort. It is a low-cost means of disseminating information to a large number of people on a broad scale. All of the foregoing says nothing of the online interstate crowdfunding platforms such as KickStarter or IndieGoGo that were built and designed to facilitate these types of transactions by providing transparency, reducing transaction costs, and providing broad choice in crowdfunding investments. These platforms are truly the perfect tools for local crowdfunding efforts.

What you can do: Please either pass a simple piece of legislation to fix this or direct the SEC to clarify or fix its intrastate crowdfunding FAQs. Otherwise, by prohibiting the use of the internet in intrastate crowdfunding, the SEC is tamping down a nascent but important opportunity to cultivate local funding and entrepreneurship ecosystems before they even have an opportunity to develop.

Fix Federal Crowdfunding. Please fix Title III of the JOBS Act the federal crowdfunding provisions that require fundraisers to use intermediaries to raise funds. Startups raise funds on their own. They don’t use intermediaries. They hustle, they work hard, they build something out of nothing. And they do it themselves. They don’t have the time, resources, or, really, inclination or temperament to outsource this activity. Startup founders and CEOs pitch investors for money directly; they don’t hire brokers.

Beyond philosophical differences, it is estimated that brokers are going to charge fundraisers 8-10% of offering proceeds. This significantly increases the costs of a transaction that were, to date, next to zero.

Federal crowdfunding will likely fail not only for philosophical reasons but because entrepreneurs won’t want to pay a broker for something they’re inclined to do themselves.

What you can do: Please pass a law removing the requirement to use an intermediary in a federal crowdfunding and authorize entrepreneurs to raise funds directly under the federal crowdfunding act.

Regarding General Solicitation:

Reaffirm General Solicitation. Section 201 of the JOBS Act was a big help to entrepreneurs in that it allowed startups to talk publicly about their efforts to raise money (this ability to talk freely about their efforts to fundraise is known as General Solicitation). Unfortunately, the SEC put rules in place rules that discourage most companies from taking advantage of this new opportunity.

You can restore the intent of Section 201.

What you can do: Please repeal the second sentence of Section 201 of the JOBS Act and direct the SEC to allow companies to speak freely about their private securities offerings.

Don’t Let the SEC Close the Door Entirely on General Solicitation. Beyond the rules that discourage most companies from general solicitation, the SEC issued additional proposed rules that will make general solicitation so cumbersome that few, if any, entrepreneurs will endeavor to try. These rules include (1) obligations to file a Form D before the company initiates its fundraising process, as opposed to after; (2) a burdensome requirement to formally file all written materials with the SEC (entrepreneurs frequently update their slides and other written materials between each meeting); and (3) a penalty for violation of the rules that includes a one year prohibition on raising money.

These rules would effectively repeal the JOBS Act.

This is what Fred Wilson, a well-known venture capitalist, had to say about the SEC’s rulemaking in this regard:

“If the SEC’s intention, with these proposed additional rules, is to neuter General Solicitation to the point that it is legal but nobody avails themselves of it, they will succeed.”

What you can do: Please order the SEC to not issue its proposed rules on Reg D and Form D.

Finally the tax changes:

Allow Startups to More Easily Share Equity with Workers. In the startup ecosystem, particularly for many early startups, cash is scarce. Instead many entrepreneurs offer their employees equity in the company as a form of compensation. There are a number of different tax-related legal hurdles that make it hard for companies to share equity with workers. Some straightforward changes could make equity sharing easier and allow entrepreneurs to grow their businesses more effectively:

First, Repeal or Remove the Imposed Tax Withholding on Stock Transfers. The Internal Revenue Code requires companies to withhold income and employment taxes when a company transfers stock to an employee. This despite the fact that under the securities laws the stock cannot be sold. This makes it very, very difficult for companies to issue stock to workers. The workers can’t afford to pay the taxes, and neither can cash-strapped startup companies.

What you can do: Repeal the law imposed income and employment taxes on non-cash transfers of stock to workers.

Second, Repeal Section Revenue Code Section 409A Related to Startups. Internal Revenue Code Section 409A was enacted to curb abuses where executives of large corporations were deferring taxes on millions of dollars of cash compensation.

This is good. However, the IRS applies the same rules it applies to multi-million dollar cash compensation packages to startup stock options. This is absurd and it doesn’t reflect the reality of startup economics.

Section 409A makes it more difficult for companies to share equity with their workers. Please repeal Section 409A as it applies to startups. Sometimes laws that are broadly applicable, across large and small, work. Sometimes they don’t. This is a case in which Section 409A works well for large companies but not for small ones. There’s no reason that startups should be hindered in transferring stock to employees. Repealing Section 409A makes employees better off and allows them to hire and retain better talent.

What you can do: Repeal Section 409A as it applies to startup and early stage company stock options and other worker equity incentives.

Renew the 100% Qualified Small Business Stock Tax Benefit. U.S. Code Section 1202 excludes from gross income a portion of the gain recognized on the sale or exchange of qualified small business stock that is held more than five years. This tax code section is a significant inducement for investing in startup companies.

President Obama convinced Congress to make the 100% exclusion, but the 100% exclusion expired at the end of 2013. It would really help startups if this 100% exclusion was made permanent.

What you can do: Make the 100% exclusion from capital gains for investments in qualified small business stock held for more than 5 years permanent.

Shorten the Holding Period Under Section 1202. The holding period to qualify for the reduced capital gains tax rate under Section 1202 is five years. This an very long holding period to qualify for a tax incentive that is supposed to encourage investments in startup company. The regular long term capital gains holding period is 1 year. A more appropriate holding period for the tax incentive to invest in startups under Section 1202 would be 2 years.

What you can do: Shorten the holding period to qualify for the reduction in the capital gains tax rate for investments in qualified small business stock to 2 years.

Extend the Rollover Period on Qualified Small Business Stock. Years ago Congress passed a tax code section, Section 1045, that was designed to encourage investments in qualified small businesses. Section 1045 allows a taxpayer to roll over their investment in a qualified small business stock into other qualified small business stock. tax free. Section 1045 is to startups what Section 1031 is to real estate However, Section 1045 has a very short window in which to make the rollover investment: 60 days.

This is great for small businesses because investments in one business can be reallocated to another business tax free. However, investors need time to transition investments from one place to another. Your typical angel investment takes months to find. Finding a rollover investment opportunity in 60 days is unrealistic.

What you can do: Extend the rollover period under Section 1045 to 270 days.

Fix Section 83(b). Currently Internal Revenue Code Section 83(b) allows founders of companies to make a favorable tax election so that they are not taxed when their founder shares vest as they continue to work for their startup. The trouble is that Section 83(b) only allows this election to be made by filing a form within 30 days of receiving stock. This is a difficult and unnecessary administrative time trap for founders. A simple change to the law could make the election deemed made rather than requiring it to be made at all.

What you can do: Please either extend the period for filing the 83(b) election to allow more than 30 days (say, allow 270 days) or reverse the presumption so that no filing is required if not tax is owed.


Startups are a key and increasingly important part of the economic engine that powers the American economy and, most importantly, creates jobs for US citizens. By making some straightforward requests, changes, amendments, and even public statements, related to a few key issues you can help make it easier for these important economic dynamos to continue to do what it is that they do so well: grow and create jobs.

Please take action to help America’s startups, small businesses, and entrepreneurs!

Thank You,

Entrepreneurship Supporter

From Startups Across America by rightbrainlaw