Restricted Stock Units
My employer offered me Restricted Stock Units (RSU). Are they good for US citizens working abroad?
Are you currently considering a position where restricted stock units are offered as part of your compensation package? This may be a new compensation model for you. If you have never dealt with RSUs, either as a traditional employee or as a digital nomad living abroad, there are a number of things you should know and consider.
What are Restricted Stock Units?
Restricted Stock Units, or RSUs, are shares of a company’s stock specifically allocated for employee compensation. They are usually listed as compensation as part of an employment contract but are not granted immediately to the employee. A vesting period of 3-5 years is average. Usually, the employee will receive a portion of the RSUs after one year, with the rest being received incrementally, either month-by-month or at the end of each year, until the full vesting period is complete.
Up to about 20 years ago, RSUs as a form of compensation were the exclusive right of top company executives and other very highly paid or privileged employees. Stock options were used as compensation for lower-level managers. After the Enron and WorldCom accounting scandals, however, where stock options were abused for profit, the FASB (Financial Accounting Standards Board) tightened its regulations on accounting for stock options. Restricted stock units rose in popularity as stock options fell, as both are methods of granting company equity to incentivize company loyalty and excellence.
Restricted Stock Units vs. Stock Options
Restricted stock units are actual units of company stock that have been reserved for employee compensation. Since they each have an inherent value, they are a slightly more stable alternative to stock options.
Stock options have no actual value, as you are not being given actual value, but simply an option to buy and sell company shares at a specific price at a later date.
For example, if you are given 5,000 shares of company stock at $5 a share as RSUs, you have a value of $25,000. If the share price goes up to $7 at the end of your vesting period, you would end up with a value of $35,000. If the share price goes down to $2 at the end of your vesting period, you would end up with a value of only $10,000. However, you would still get something. The only way you would get nothing from your RSUs is if the company’s share price became zero.
On the other hand, if you were given stock options, things would look a little different. If you were given the option to buy 5,000 shares of company stock at $5 a share, this option will be worthless unless the share price goes up. Continuing with the same scenario as before, say the stock price goes up to $7 a share. You could buy the shares at $5 and immediately resell at $7, making a $10,000 profit. However, if the share price dropped to $2, your stock option would be useless.
In either case, you must ensure that your personal financial security is not dependent on your company’s performance. Even with more stable RSUs as part of your compensation package, you must ensure that you will still be financially robust if your RSUs decline in value. If you have the ability to negotiate, choose a percentage of RSUs vs. cash that will allow you to take advantage of stock price increases, while not exceeding your personal risk level.
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How to Account for RSUs in Income
Restricted stock units do not have any tangible value before they are vested. Since they are nothing but a promise before the vesting period is over, they are not tangible assets and therefore not taxable. RSUs are taxed as income in the year that they vest. Their value in income is based on the share price at the time of vesting.
For example, suppose you have 4,000 shares of restricted stock units that are awarded to you on a 4-year vesting schedule. You receive 1,000 shares at the end of each year.
- Year 1: Share price was $20. You are taxed on $20,000 in ordinary income.
- Year 2: Share price was $22. You are taxed on $22,000 in ordinary income.
- Year 3: Share price was $25. You are taxed on $25,000 in ordinary income.
- Year 4: Share price was $27. You are taxed on $27,000 in ordinary income, for a total of $94,000 in ordinary income.
- Year 5: You sell all 4,000 of your shares at $30 per share, making a total of $120,000. Since you have already paid taxes on $96,000 worth of your shares, you are taxed at the capital gains tax rate on the difference, for a capital gain of $26,000.
Alternatively, if you sold your shares immediately upon receiving them each year, you would only be taxed on the ordinary income and would have no capital gain. If you hold your shares for longer than two years after total vesting, you are taxed at the long-term capital gains rate. Consult with an accountant or tax advisor for the tax implications of your individual situation.
RSUs as an American Abroad
Americans living abroad, or those who are considering giving up their citizenship, have a few extra considerations when it comes to investing and stock compensation.
Investing restrictions
Americans living abroad may be subject to regulatory limits when it comes to holding certain stock-based investments. If you live outside of the United States, you may not be allowed to open a US bank account or mutual fund account. Large investment companies such as Charles Schwab and Fidelity have announced that no American living abroad, including their own employees, is allowed to purchase their mutual funds (with limited exceptions for 401(k) plans). ETF’s, however, are still available choices for most foreign-dwelling Americans who wish to make new stock purchases.
This may not be an issue for RSUs specifically, but since it is wise to have a diversified portfolio, Americans who hold RSUs should know about restrictions on other investments they may wish to make.
Taxation considerations
Once vesting occurs, both the United States government and the government of the foreign country where you live will be interested in taxing that money.
- Research whether your country of residence has a tax treaty with the United States. You may be able to avoid double taxation, or minimize your taxes for one country or the other, if such an agreement exists. In any case, you can claim the Foreign Tax Credit on your US taxes to offset taxes paid in another country.
- Be aware that if you are in a country with high ordinary income and capital gains tax rates such as the EU countries, your company may sell off some of your newly vested shares for you in order to make the appropriate tax withholding for you.
- There are a few countries that do not tax your investment gains at all as long as that money never enters their country. If this is the case, you will only need to consider your US tax liability on that money.
- If you are not only living abroad but considering giving up your US citizenship altogether, be aware that wealthy individuals (covered expatriates) may still be subject to a US “exit tax” at the time of expatriation. Covered expatriates generally have a net worth of more than $2 million dollars and an average annual income tax liability of more than $165,000, so there aren’t a lot of people who will fall in this category. If you think you might fall into this category, and you have RSUs from an American company, read on. Eligible RSUs that you own or have come to you at the time you give up citizenship are taxed at a 30% rate based on the value at the time of vesting, even after you have given up your citizenship when they vest.
Restricted stock units can be an attractive compensation option for both employers and employees. The incentives for employee retention and excellence are obvious, and the guarantee of value makes it a stable option for employees. Most Americans overseas will also not have undue trouble with RSUs in a compensation package. In any case, be sure to do your research and consult with a financial advisor or tax professional for your specific circumstances. Overseas Americans must be sure that their chosen advisor is well-versed in foreign as well as US tax topics.
Expat Tax Online is a complete tax preparation service for Americans living abroad, and are well versed in the challenges that US citizens may face when dealing with taxation in two countries. Contact us today to prepare a return, file taxes, or chat with one of our tax experts.
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