Factors in RSU Taxation
Restricted Stock Units are taxed differently from regular salary or investment income, and understanding these factors helps you plan better. The tax treatment depends on how and when the RSUs vest, how long you hold the shares, and whether you make a profit when you eventually sell them. Here are the key elements that influence RSU taxation.
Tax at the time of vesting
RSUs are taxed as part of your salary income when they vest. The market value of the shares on the vesting date is added to your taxable income and taxed according to your income tax slab.
Perquisite valuation
The fair market value (FMV) of the shares on the vesting date is considered a perquisite. This value is used to calculate how much tax is added to your salary income for that financial year.
Taxation when shares are sold
Once you sell vested shares, any profit or loss is treated as capital gains. The gain is the difference between the selling price and the FMV considered at vesting.
Short-term vs long-term capital gains
Tax on capital gains depends on the holding period. Selling within 12 months results in short-term capital gains, while selling after 12 months leads to long-term capital gains, each taxed at different rates.
Double taxation misconception
Although RSUs are taxed twice in different stages, the FMV taxed at vesting becomes your cost of acquisition, ensuring no tax is paid on the same portion again.
Tax Implication on Sale of RSU Holdings
When you sell shares received through RSUs, the tax treatment depends on whether the shares were sold immediately after vesting or held for a specific period. RSUs are first taxed as salary at the time of vesting. After this stage, any gain made at the time of selling the shares is treated as capital gains. The tax rules differ for listed and unlisted shares, and the holding period plays a major role in determining whether the gain is short-term or long-term.
If the RSU shares are listed on an Indian stock exchange, the short-term capital gains apply when the shares are sold within 12 months. Long-term capital gains apply when the holding period exceeds 12 months. For unlisted shares, the holding period criteria are longer and the tax rates vary. There is also no long-term exemption for unlisted RSU shares.
Capital gains are calculated based on the Fair Market Value (FMV) used during vesting, which becomes your cost of acquisition. This ensures that the income taxed at vesting is not taxed again, and only the appreciation after vesting is taxed.
Category
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Shares listed on Indian Stock Exchange
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Shares not listed on Indian Stock Exchange
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Short-term capital gain
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If held < 12 months, taxed at 20% (15% if sold before 23 July 2024)
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If held < 24 months, taxed as per slab rate
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Long-term capital gain
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If held > 12 months, taxed at 12.5% (10% if sold before 23 July 2024)
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If held > 24 months, taxed at 12.5% (no indexation)
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Exemption
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LTCG up to ₹1.25 lakh is exempt
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No exemption
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Indexation
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No
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Available for LTCG
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Why do companies use restricted stock units?
Now that you are familiar with RSU’s meaning, let us take a look at its key benefits:
- Alignment of interests: RSUs make employees feel like they own a part of the company. This makes them want to work harder because they want the company to do well.
- Retention: RSUs often have rules that make employees wait a few years before getting the shares. This makes employees more likely to stay with the company for a long time. When people stay longer, the company has a stable team, which helps it succeed.
- Attracting talent: Offering RSUs is a good way to get talented people to work for the company. It shows that the company values its employees and wants to reward them for their work.
- Cost-effectiveness: RSUs can be cheaper for a company compared to other types of stock rewards like stock options. With RSUs, the company gives actual shares to employees, so it is clear how much it costs. With stock options, the cost can change because it depends on the stock price.
How do restricted stock units work?
Restricted Stock Units (RSUs) are company shares granted to employees as part of their compensation, but they are subject to a vesting schedule. Employees receive the shares only after meeting specific conditions, such as time or performance milestones.
Key points on how RSUs work:
- Granted with a vesting schedule (time-based or performance-based).
- No value or ownership until vested.
- Converted into actual shares upon vesting.
- Taxable as income at the time of vesting.
- Encourage employee retention and long-term performance.
Also read: Undervalued stocks
Example of RSUs
Consider an employee who is granted 1,000 RSUs by their employer, with a 4-year vesting schedule.
- Year 1: 25% (250 shares) vest on the first anniversary
- Years 2–4: 25% vests each year thereafter
- After 4 years, the employee owns all 1,000 shares, assuming they stay with the company through the vesting period.
Restrictions on RSU
Restricted Stock Units come with certain conditions that determine when employees actually receive ownership of the shares. These restrictions ensure that RSUs align with company goals, encourage long-term retention, and reward performance over time. Understanding these limitations helps you plan better for vesting, taxation, and future financial decisions. Below are the key restrictions commonly applied to RSUs.
Vesting period requirements
RSUs are not granted immediately. They vest over time or based on milestones. Until vesting is complete, the employee does not own the shares, and unvested RSUs cannot be transferred or sold.
Performance-based conditions
Some RSUs vest only when specific targets are met, such as revenue milestones, project completion, or individual performance ratings. Failure to meet these targets may delay or reduce vesting.
Employment tenure conditions
Most RSU plans require employees to remain with the organisation until the vesting date. If an employee resigns or is terminated before vesting, unvested RSUs usually lapse.
Lock-in or sale restrictions
Even after vesting, some companies impose lock-in periods during which employees cannot sell their RSU shares. This ensures stability in shareholding and avoids sudden selling pressure.
Clawback policies
Companies may enforce clawback rules, allowing them to reclaim vested RSUs in cases of misconduct, violation of policy, or financial restatement. This protects the organisation from undeserved payouts.
Advantages of RSUs
Restricted Stock Units (RSUs) are a popular form of equity compensation that offer several benefits to employees. Unlike stock options, RSUs retain value even if the company’s stock price fluctuates, making them a reliable form of long-term incentive.
Key advantages include:
- Guaranteed value upon vesting: RSUs always have value once vested, regardless of stock price movements.
- No upfront cost: Employees do not have to purchase the shares they are granted by the employer.
- Encourages retention: RSUs typically vest over time, motivating employees to stay longer with the company.
- Potential for wealth creation: Employees benefit from stock appreciation over time, potentially leading to significant gains.
- Simpler than stock options: RSUs involve fewer decisions and risks compared to managing stock options.
Risks and considerations with RSUs
While RSUs offer value, they come with certain risks and limitations.
- Delayed ownership: You do not own the shares or benefit from dividends until vesting is complete.
- Tax implications: RSUs are taxed as ordinary income upon vesting, which could push you into a higher tax bracket.
- Loss on job change: Unvested RSUs are forfeited if you leave the company before the vesting period ends.
Conclusion
Restricted stock units are not just a way to pay employees; they connect how hard employees work with how well the company does. RSUs make employees feel like they own a piece of the company, so when the company does well, they do, too. This motivates the employees and helps everyone succeed together.
