The Downside of Equity-Based Compensation
Over the decades, many companies have switched at least part of their executive compensation to equity-based through the use of Restricted Share Units (RSUs).
You aren’t guaranteed income like you are through a salary, but it gives you a chance to build wealth even faster – if the stock price is going up, of course!
But what happens if you receive equity and then the stock price goes down? Tech employees are experiencing this right now as we’ve come off the market peaks from the last month.
The Mechanics of RSUs
For this example, let’s review RSUs that were “granted” in previous years but didn’t “vest” until January 1st, 2022. Generally, you’ll learn how many shares you’ll receive when the award grants, and then you’ll receive those shares upon vesting.
Let’s use an example of an Accenture (ACN) RSU grant of 100 shares that vested on January 1st, 2022. January 1st was a Saturday, so the shares didn’t officially vest until Monday, January 3rd, and the vesting price is the midpoint between the high and low prices of the day.
On that day, ACN peaked at $415.53 and bottomed at $414.66, making the vesting price $415.10. This price also happens to be right near the all-time for the stock.
In our example, our 100 shares vested at $415.10, making the total amount of $41,510 taxable as income.
Tax Results of the Vest
Our example of 100 shares vested with a value of $41,510, but what happens next?
Most people choose to withhold shares to cover taxes. Let’s say we’re in a state with no income tax, so we only need to plan for Federal tax. There’s a standard 22% Federal tax withholding on supplemental income, so you’ll lose around 22% of your shares to taxes.
After taxes, we’ve received 78 shares in our account.
Since we already paid taxes at vesting, the cost basis of the shares is locked in at the vesting price ($415.10). There wouldn’t be further tax consequences if you sold the shares right away at the same price.
However, if the stock price went up or down since vesting, you’ll now be subject to capital gains taxes.
Selling the Shares
Many people will treat the RSU awards as extra income and sell right away to harvest the cash. There’s one major issue, though: the shares take 3-5 days to “release” to your account before you can sell them.
The delay between vesting and release usually doesn’t cause a problem, but in our example with ACN, the stock price dropped from $415/share on Monday to $379 on Friday!
The value of our 78 remaining shares dropped from $32,377 to $29,562, or nearly 9% before we could even touch them!
Now we’ve paid taxes on 100 shares vested at $415.1, but we have to decide if we want to sell the shares at $379 for a $36/share loss.
Selling Shares at a Loss
Some people view RSUs as “free” money, so they may not be concerned about selling for a loss. In this example, $379/shares look pretty good as ACN is now down to $350/share (as of January 18th).
Selling shares at a loss can also allow you to claim the loss on your taxes, offsetting taxable income by up to $3,000. This would help us feel less pain from paying income tax on the entire $415.1/share.
However, the “wash sale” rule negates the ability to claim a loss if you’ve purchased the same shares 30 days before or after the sale.
This becomes a big problem if you’re an Accenture Managing Director who participates in the VEIP! Since you’re purchasing every month, you won’t be able to claim the capital loss triggered by the drop in share price.
Strategies to Manage a Price Drop after Vesting
With stock prices falling, many people are in a similar position.
If you don’t need to generate cash, it could make sense to hold on for a while and see what happens to the stock price. However, if you need an infusion of cash in the next year, this might not be an option.
We never know what’s going to happen to stock prices from here, so it comes down to the immediacy of your need along with your other sources of cash.
Ideally, if you have additional shares you’ve purchased in the past with a lower cost basis, you can sell them and hold on to the stocks that are underwater.
Accenture has more than doubled in value since the “COVID crash” in March 2020, so there’s a good chance many people will own shares with a cost basis in the $200s.
The strategy should also be exercised with caution as you can trigger short-term capital gains if you haven’t held longer than a year, making the earnings taxable as income.
In the end, it’s dependent on your situation and needs for cash flow. I focus on this type of work with my clients, so please use this post for informational purposes only and speak with a professional about your situation.
