RSU Tax Vs. PSU Tax

RSU Tax Vs. PSU Tax.

RSU and PSU are two types of stock-based compensation employees can receive from their employers, in this article we are going to look at RSU Tax Vs. PSU Tax. in detail.

In fair market value cases, RSU (Restricted Stock Unit) is treated as ordinary income for tax purposes (federal income tax).

However, PSU (Performance Share Unit) is treated differently. 

With PSU, the employee does not become the stock owner until certain performance milestones are met. 

This means the employee does not have to pay taxes on the stock until it is considered vested.

Let’s learn more about the differences between the two regarding taxation.

So if you are considering RSU Vs. PSU compensation, you need to understand how they are taxed.

What is RSU (Restricted Stock Units)?

RSU stands for Restricted share/stock units.

Restricted stock units RSUs are given to employees after they achieve specific goals or have worked for a company for some time.

This type of stock-based compensation differs from regular stock options because the employee does not have to pay anything upfront to exercise the option.

Instead, RSUs vest over a certain period, and once they are vested, the employee is entitled to receive the number of shares specified by their RSU agreement.

RSUs can be issued as cash bonuses, stock options, or restricted stock awards.

They are often used to reward employees and incentivize them with a long-term investment in the company’s stock.

RSUs can benefit employers and employees because they help align their interests — when the company performs well, so does the employee who owns RSUs.

However, it’s a taxable income subject to capital gain tax, so you must pay capital gains tax when selling the company stock. 

So, it’s essential to understand the taxation rules of your country and plan accordingly when comparing RSU Tax Vs. PSU Tax.

What is PSU (Performance Stock Units)?

PSU stands for performance share/stock unit, which is very popular among public companies. 

It’s a type of long-term incentive plan wherein employees are rewarded with shares based on their performance and other objective criteria set by the company.

The company can grant PSUs or allow the option to buy stocks instead of cash bonuses or salary increments.

These are linked to certain milestones an employee needs to achieve during a predefined period.

PSUs are subject to vesting conditions and specific performance criteria over a period, after which the employee would be entitled to receive the number of shares specified by their PSU agreement.

They can also include other financial incentives, such as dividend payments or reduced fees for future stock purchases.

Like RSUs, PSUs can benefit both employers and employees as they help align their interests—when the company performs well, so does the employee who owns PSUs.

The main difference between RSUs and PSUs is that RSUs vest over a certain period, while PSUs only vest when specific performance criteria have been met. 

This makes them ideal for companies seeking to reward employees for long-term performance or specific goals.

Like PSU, you pay tax on capital gains when you sell the stock.

What is RSU Tax?

RSU tax is the taxes you must pay when selling your restricted stock units.

RSU tax can be complicated and depends on several factors, such as the type of RSUs, RSU income, vesting period, stock price, holding period, and country where you reside.

It’s similar to any ordinary income tax you pay on your income. 

The difference is that RSU tax is based on the value of your stock at the time of sale and not on the actual amount received when you sold them.

Understanding how taxation works on RSUs.

First, you must understand that RSUs are considered a form of income when selling them. 

Since the value of your stock can fluctuate over time, you may end up with a higher or lower tax bill depending on the value at the time of sale.

Under US federal law, any income from selling RSUs is subject to federal income tax and applicable state and local taxes.

Depending on the situation, you may also be subject to Social Security and Medicare taxes (commonly referred to as FICA or payroll tax).

Regarding capital gains tax, if you sell your RSUs within a year of vesting, the gain is taxed as ordinary income. 

If you hold the RSUs for more than a year, any gain or loss is subject to capital gains tax rates, which are generally lower than ordinary income tax rates.

It’s important to remember that if you have RSUs issued in different years, they may have different holding periods, so the taxation rules can be complicated. 

The best thing to do is to consult a tax professional to ensure you meet all the requirements.

It’s essential to understand the taxation rules of your state, so consult a professional tax specialist for legal or tax advice before you exercise your RSUs.

What is PSU Tax?

Like RSU tax, PSU tax is the taxes you must pay when you sell your performance stock units. 

As with RSU tax, PSU tax depends on several factors, such as the value of shares, vesting period, and holding period.

However, it may differ slightly regarding the tax rate or other applicable taxes like state taxes and FICA. 

In the US, a portion of any gain from selling PSU shares is generally subject to capital gains tax, while the other amount is subject to ordinary income taxes.

Understanding how taxation works on RSUs.

The exact taxation rate and rules depend on your situation and should be discussed with a professional tax specialist.

It’s also important to note that some states may have specific rules and regulations that apply to PSU taxes.

It’s essential to check with your local tax authority to ensure compliance.

In addition, the taxation rules for shares sold in different years may vary, so consult a professional for proper guidance.

But in general, the taxation rate for PSUs is the same as that of RSUs and other capital gains.

It’s important to remember that if you own PSU shares, they may be subject to both ordinary income tax and capital gains tax, depending on how long you hold them before selling.

So understanding the taxation rules of your country or state is critical to ensuring that you pay the correct taxes on your PSU income.

RSU Tax Vs. PSU Tax.

So now that we know how PSU and RSU work, let’s dig deep into their differences.

PSU advantages.

1. The better you perform, the more you earn: 

PSUs are performance-based bonuses that reward you with stock options when your company does well. 

This means you can earn a higher return than with other forms of stock-based compensation.

2. More flexibility: 

Since PSUs are tied to performance, it allows for more flexibility when deciding how and when to exercise your stock options. 

So you can take advantage of market fluctuations to maximize your profits.

3. Better productivity: 

The potential of earning higher returns encourages employees to be more productive and, thus, contributes to the company’s profitability.

This led to more job satisfaction and increased performance.

So employers are benefiting from PSUs too.

4. Job security: 

Since PSUs are performance-based, employees are more likely to stay with the company longer. 

This increases job security and allows employers to build a loyal workforce.

This also encourages employees to be more committed to their work.

PSU Disadvantages.

1. Can be costlier for employers: 

Since PSUs are tied to performance, they can be more expensive for employers than RSUs. 

The company has to pay out stock options based on actual performance.

2. Unpredictable outcomes:

Since the business’s success depends mainly on external factors such as economic conditions and market trends, predicting the outcome of any PSU-related investments is challenging. 

This can make it difficult for employers to properly gauge the financial implications of issuing stock options.

3. Complex taxation: 

Since PSUs are subject to ordinary income tax and capital gains (depending on how long you hold them before selling), understanding the taxation rules is essential when exercising your stock options.

RSU advantages.

1. Incentivize employees to stay with the company: 

So the first and most obvious advantage of having RSUs is incentivizing employees to stay with the company longer. 

This helps create a more loyal and committed workforce, leading to increased productivity and better results.

2. Reduced administrative costs: 

Another benefit of RSUs is that they have fewer associated administrative costs. 

This allows companies to save money on issuing Equity and managing the stock portfolio. 

This is because RSUs are generally easier to manage and track.

3. Tax benefits: 

RSUs also offer certain tax advantages to employees.

Employees receive the capital gain minus the value of shares withheld for income taxes; this means they can benefit from a lower tax burden.

4. Reduced volatility:

RSUs are less volatile than PSUs because they don’t fluctuate in price like stocks. 

This makes them a more durable option for companies to issue equity since the value of the shares is generally consistent and predictable over time.

RSU Disadvantages.

1. Can tie employees to a company: 

While RSUs can be an effective way to incentivize employees, they also have the potential to tie them to a company for too long. 

This could create employee retention and morale issues if the company isn’t performing as well as it should be.

2. Limited upside: 

Another downside of having RSUs is that the upside is limited.

Employees can only benefit from the appreciation of their shares up to a certain point, and any excess value will not be given to them. 

This means that there is no potential for genuinely massive returns through RSUs.

3. Stock prices can fall: 

Lastly, there is always the risk that stock prices can fall.

This could result in losses for employees who have invested in RSUs. 

So it’s essential to consider this before investing any money into RSUs. 

This means that employees should know the risks of investing in stocks.

Which one is better: RSU or PSU?

The answer to this question ultimately depends on the situation. 

Generally speaking, RSUs tend to be more beneficial for employees due to their simplicity and tax advantages.

On the other hand, PSUs are better suited for companies with a longer-term outlook and can benefit from increased performance metrics related to stock options.

It mainly depends on a company’s business model and the individual employee’s needs and goals.

For example, a company wants to incentivize its employees to stay with the organization longer. 

In this case, RSUs could be a better option since they offer more stability and fewer administrative costs.

If, on the other hand, the company is expecting significant growth shortly and wants to reward its employees accordingly, then PSUs could be the more suitable choice.

Ultimately, it comes down to the company’s specific needs, goals, and individual employees’ preferences. 

It is essential to consider all of these factors when deciding whether RSUs or PSUs are the better options for your particular situation.

Final Thoughts.

So there you have it RSU Tax Vs. PSU Tax.

RSUs and PSUs are subject to tax and administrative benefits, but which is better depends on your specific situation. 

RSUs are generally more straightforward and provide more stability.

While PSUs can be advantageous if a company expects significant growth over time. 

It is essential to evaluate both options before making any decisions.