by 5paisa Research Team Last Updated: 2022-12-13T17:06:58+05:30
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A Restricted Stock Unit (RSU) is a type of stock-based compensation that an employer can offer as a benefit. This is an important term to understand as RSU may be a part of the remuneration package in the job posting. Learning about RSUs and their benefits can help you negotiate better working conditions during the hiring process.

This article describes RSUs meaning, benefits, and potential drawbacks, and provides examples of how they work.

What Is a Restricted Stock Unit (RSU)?

Restricted Stock Units (RSUs) refer to a grant of value equal to the amount of common stock in the company. RSUs are typically granted to new or valued employees as an incentive to hire or to achieve certain performance goals. For new hires, the RSU plan is typically part of the employee's initial compensation package. RSUs are very popular with startups and technology companies looking to hire and retain highly skilled and talented employees.

Understanding Restricted Stock Units (RSUs)

Now that you understand the restricted stock unit meaning, let’s dive deeper. When an employee gains access to a restricted stock unit, they should decide whether to accept or decline the given grant. If the employee accepts the grant, the employee may be required to pay the employer the purchase price of the grant.

After receiving and paying the grant (if applicable), the employee must wait for the grant to mature. The vesting period for restricted stock units can be time-based (a specified period from the date of grant) or performance-based (often linked to the achievement of corporate goals).

When restricted stock units mature, employees receive an unlimited amount of company stock or cash equivalents (depending on the company's plan rules). Your company may allow or require you to defer receipt of stock or cash equivalents to a later date (again, subject to company planning rules).

Advantages and Disadvantages of RSUs

RSUs have pros and cons for both employers and potential employees. Benefits for Employers using RSUs:

RSUs can be used by some companies, notably Dropbox, Twitter, Airbnb, Square, etc. Suitable for RSUs are not often used in early-stage companies. Other benefits:

●    Opportunity to attract employees as they can offer additional incentives.
●    Saving money as they offer compensation without any upfront payment.

Disadvantages for Employers Using RSUs:

Like all other employee incentives offered, the issuance of her RSUs by a company has some disadvantages. These include:

●    Your stock may not be appreciated enough to reward your employees.
●    RSUs are not always a sufficient incentive to attract the right people.
●    RSUs are valued when the shares vest, so the ultimate value is unknown when the RSU Plan gets created.

Benefits for Employees Receiving RSUs

●    Your employer provides financial interest in the company in the form of equity.
●    After the transfer, you will own the shares at their current market value.
●    Earnings may be higher than originally expected, depending on the value of the shares at the time of the transfer.

Disadvantages for Employees Accepting RSUs:

●    The value of your stock may not be as great as you expected.
●    Normally RSU is not fully vested for 5 years. This means that if you leave the company before that date, you will not be able to claim any or all of your stock units under the RSU plan.

Examples of RSUs

Suppose a person receives a job offer from a company. The company believes this employee’s skills will be an asset to the company. Therefore, the company decided to provide them with 600 restricted stock units as part of their compensation, apart from their large salary and other benefits. The company's shares trade at a market price of Rs. 50 per share, which equates to the value of their 600 RSUs over Rs. 30,000. Market price determinations are usually based on the stock's previous day's closing price or the average of the day's highs and lows.

However, if you receive the Rs. 30,000 incentive, you must work for the company for five years due to the lock-in period. An individual is entitled to receive 20% of the total RSUs at the end of their first year. In the second year, they made up another 20% of the total RSU. This continues until he has all 600 RSUs by the end of Year 5. Regardless of the price of the stock at the end of the fifth year, that person will receive about Rs. 30,000 at the end of her fifth year.

RSU, therefore, acts as a motivator within the organization. Not only will it allow employees to stay with the company, but it will result in better employee performance and, ultimately, better stock performance. For example, if the person stays with the organization for the next five years and receives all 600 RSUs, at which point the stock price rises to Rs. 70 per share and will eventually receive approximately Rs. 42,000. However, this is taxable income, and companies retain a portion of the shares for income and capital gains tax purposes.

On the other hand, if you leave your job during the period of suspension, you will not receive this allowance. For example, assuming that person quits their job after one year of employment, they will only have 150 RSUs available and will lose the remaining 450 shares of the company.

What are the Restrictions on RSUs?

RSU Restricted Stock Units may have various types of restrictions that may prevent the expiration of the vesting period. Here are the different types of restrictions on these assets: Therefore, if a particular employee decides to keep their position with the company for a given period, the time-based restrictions are lifted.

Milestone-Based - In addition to time-bound constraints, some constrained SKUs are locked past milestones that beneficiaries must complete. The RSU vesting period will end when this goal is achieved. For example, a sales coordinator can unlock RSUs in their name by achieving a certain number of sales in a year.

Based on Time and Milestones – In some cases, both time and milestone limits apply to their Restricted Stock Units to be able to sell such assets, the beneficiary must pass the set milestones and deadlines set by their employer.

Owning an RSU is like owning a part of the company you work for, but only a small part. However, obtaining an RSU in a usable format requires the removal of various existing restrictions.

What to Do with RSUs?

After the completion of the allotment, individuals can sell some or all of their shares for a significant profit. However, it is advisable to sell all accumulated shares, especially if stock prices are known to fluctuate frequently.

Similarly, it should be remembered that holding such shares is akin to buying them on that particular day. If the stocks are already expensive, they may not be worth holding as prices may not rise consistently. Regardless of the decision, employees can make large profits by selling restricted stock units.

Taxation on Restricted Stock Units

Typically, employees receiving the restricted stock units are not taxed on the grant date. Instead, the employee will be taxed upon vesting (when the restrictions expire) unless the employee chooses to defer receipt of cash or shares. In such circumstances, the employee must pay the statutory minimum tax set by the employer at the time of vesting, but all other tax payments are due at the time of the distribution when the employee receives the shares or cash equivalents. Taxable income is the difference between the market value of the award at the time of grant or distribution less the amount paid for the prize if any.

For awards paid in the actual stock, the employee's tax holding period begins at the time of award (which may or may not coincide with vesting, depending on plan rules), and the employee's tax base is Amounts paid in shares and amounts included in regular levelled income. Upon a later sale of the shares, assuming the employee holds the shares as a capital asset, the employee would recognize capital gain income or loss; whether such capital gain would be a short- or long-term gain would depend on the time between the beginning of the holding period at vesting and the date of the subsequent sale. Consult your tax adviser regarding the income tax consequences for you.

RSUs can be a good way to hire and retain talent for the company’s growth. However, performing a cost-benefit analysis is beneficial before offering or accepting restricted stock units.

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