The Big Question #32: How Are My RSUs Taxed

Hello everyone, and welcome to this month's special edition of The Big Question, specifically for our Merck and big pharma executives. We have, over time, seemingly run into a few of the same questions as it relates to RSUs: how they vest, and the tax implications at each stage. For this reason, we wanted to take a few minutes to review exactly that. How are my RSUs taxed? Now, to keep this simple, we'll review this more as a before, during, and after. The before will cover everything prior to vesting. The during will cover the actual vest date. And the after will cover everything thereafter.

Now, on the before side, each spring you receive a grant with your newest tranche of RSUs. Effectively, there's no tax impact yet. Nothing is realized. You simply now hold this phantom asset. But because you do not have access or control, there are no tax consequences to navigate.

Now, from a during perspective, on the date of vesting, you realize a bunch of ordinary income based upon the current value of the shares that just vested. Now, I want to be very clear here, because this is often the first place of confusion. How the share price has moved up or down since your grant date does not matter from a tax perspective. You didn't gain anything, nor did you lose anything. On the vest date, and only on the vest date, is there an action that has tax implications, and it is all related to W-2 ordinary income. So, for example, if you were to receive 100 shares and the share price is $100, then you just received what is the equivalent of $10,000 in ordinary W-2 income. Now, what you've also likely noticed is that by default, Merck will withhold the equivalent of 22% in taxes in the form of shares. So you won't receive your full 100 shares, you'll receive 78, or the 100 shares less 22 shares that are withheld for taxes. Now, one final note here: as a high earner, this is often less than you actually do owe due to this large influx of income. So, either personally or with your tax professional, you're going to want to ensure that you're prepared for whatever may be due come April to fund this gap.

Now, your shares have vested, what's next for taxes? What does the after look like? After this, you enter short- and long-term gains territory. From the very first day you vest through one year and a day later, you will live in short-term territory. That means that any gains or losses realized during this period will be categorized as short-term. Now, why this matters is that if your shares begin to increase immediately and you sell them at any point in that first year, it is a short-term gain, which again will be taxed as ordinary income. Now, why this is so important, as just mentioned, you're likely already going to be in a very high tax bracket. So, this has a good chance of being taxed somewhere in the 30 to 40% range. So, often how we think about it is, if you're willing to hold the shares for one day, you better be willing to hold them for one year, after which you then shift back to more favorable long-term gains territory, generally taxed at far friendlier rates.

Now, as you can imagine, our preference is to typically sell these shares immediately on the day of vesting. Or, as one of our great friends and clients says, "Our preference is to ruthlessly exit the position." We do this for a few reasons. First, we feel we can then better manage our tax bill, notice we said manage, not necessarily avoid. Secondly, we can immediately decrease our exposure, and therefore our risk, to Merck, the company that also pays your salary, your benefits, your health insurance, your pension, and so forth. Now, for those of you feeling curious or nostalgic, if you're wondering whether you'd have been better off holding your shares in Merck or the S&P 500 over the past 5, 10, or 20 years, I can recommend a great video by my colleague Jerry Davidse on that exact topic, one you'll also find in the show notes.

Now, those few things alone are plenty. We don't see the need to add additional risk by maintaining a large concentrated stock position, especially when you're likely to continue to receive large tranches year over year, still allowing you to participate in any upside. And if you find yourself struggling with any of this, navigating or understanding the taxes, how and when to diversify, or simply just selling due to that nostalgia, that's where our team comes in. I'd recommend you let us take this off your hands so you can reallocate that focus to other areas of your life that are just as important but perhaps more of interest. Thanks for joining me everyone. Until next month.