Capital Gains on Stock Options and RSUs: A Comprehensive Overview
Stock options and restricted stock units (RSUs) are popular forms of employee compensation that offer employees the opportunity to own a piece of their company. However, they come with certain tax implications that can be confusing for many people.
When you exercise your stock option or receive RSUs, you become the owner of the underlying shares. If you later sell these shares at a profit, this is known as a capital gain. Capital gains can be either short-term or long-term depending on how long you hold onto the shares before selling them.
If you hold onto your shares for less than one year before selling them, any gains will be considered short-term capital gains. Short-term capital gains are taxed at your ordinary income tax rate, which can be as high as 37 percent in 2021.
On the other hand, if you hold onto your shares for more than one year before selling them, any gains will be considered long-term capital gains. Long-term capital gains are subject to lower tax rates than short-term capital gains. In 2021, long-term capital gains are taxed at rates ranging from zero percent to 20 percent depending on your income level.
It’s important to note that when you exercise stock options or receive RSUs, you may also face taxes based on the difference between the fair market value of the shares and what you paid for them (known as the “bargain element”). This amount is added to your regular income and taxed accordingly.
Additionally, some companies offer employees the option to pay taxes on their stock options or RSUs upfront instead of waiting until they sell their shares. This is known as an early exercise or Section 83(b) election and can have its own set of tax implications.
In summary, understanding how capital gains work with stock options and RSUs is crucial for anyone who receives these types of compensation packages from their employer. By knowing the tax implications of exercising and selling your shares, you can make informed decisions about managing your finances and minimizing your tax liability.