Sell to Cover? What Tech Employees Need to Know for RSUs and Stock Options
“Normal” for most salaried professionals isn’t “normal” for tech employees. But you already know about this – with RSUs, stock options, bonuses, and other benefits, you’re in a unique position when it comes to your financial compensation.
It means a lot of good for your wealth-building potential, but also a lot of headaches as you navigate the best path forward. Especially when it comes to RSUs and stock options, the tax liabilities and the cost to exercise can make it feel impossible to benefit.
What should you know about sell to cover options and their tax implications?
This guide will walk you through the basics of sell-to-cover exercises so that you can make your own decisions about what method works best for you.
What is a Sell-to-Cover Exercise?
If you are granted stock options or restricted stock units as part of your compensation package at a major tech company, you may want to consider a sell-to-cover exercise. Selling to cover (also known as a cashless exercise) means that you sell shares received from exercising your stock options to offset the initial cost of buying the shares or to offset tax liability on restricted stock units.
This is beneficial for several reasons. First, it helps you offset the out-of-pocket expense of using your stock options. While many people would like to invest in the companies where they work, it can be unfeasible to exercise their full stock option based on the expense alone.
Second, you might be on the hook for taxes on the difference between the exercise price and the market price. By selling some of those assets, you reduce the tax liability you will incur on your initial purchase.
Sell to Cover for RSUs
Restricted stock units or RSUs are a definite perk for many tech company employees, but they do come with some tax implications. Selling to cover is a common strategy that minimizes taxes paid on those stock units in the year that they vest. How does this work in practice?
Let’s say that you receive 100 RSUs after five years of working for your company. The end of your fifth year comes around, and those restricted stock units vest at a value of $50 each. That means that your RSUs have a value of $5,000 that will be subject to taxes.
Your company is required to withhold taxes on this income. Assuming a supplemental withholding rate of 25% (including federal and state taxes), your company would need to cover $1,250 in taxes. To do this, they would sell 25 shares to balance out what you would owe, leaving you with 75 shares.
Keep in mind that if the price of the share increases in the future, you may still be responsible for capital gains taxes on the difference between the value on the day they vest and the day you sell. Because you hold onto those 75 shares, you can benefit from growth in the market, though you will need to make sure you have enough to cover capital gains.
Sell to Cover for Stock Options
While restricted stock units are complex enough on their own, other stock options can also utilize the sell-to-cover exercise. This can help offset the initial cost or strike payment as well as taxes due on the transaction.
Consider this simple scenario: As an employee, you have the option to purchase 100 shares at $10, which will cost you $1,000. The current market value of each share is roughly $20. The broker who buys and sells the shares will cover this price by selling the number of shares needed to cover the exercise price ($1,000). This means they would need to sell 50 shares to cover the cost.
Keep in mind that if you sell the shares now to offset your strike price, you might lose out on any potential gains those stocks would have incurred.
Much like RSUs, you will have to pay capital gains taxes on future sales if the market value of your assets increases from the discounted price at which you purchased them. This could increase your tax liability, but it may ultimately be worth it to you.
Sell to Cover Overview
Feeling a little overwhelmed by the intricacies of a sell-to-cover exercise? This chart will help you see exactly how the exercise works for stock options and RSUs so that you can make the right choice for you.
| Feature | Sell to Cover for Stock Options | Sell to Cover for RSUs |
|---|---|---|
| Costs Covered | Exercise price of the options AND applicable income taxes. | ONLY the income taxes due upon vesting. |
| Triggering Event | The employee's decision to exercise their vested options. | The vesting of the RSUs, which is typically automatic based on a predetermined schedule. |
| Primary Purpose | To fund the purchase of shares and cover the resulting tax liability without a significant out-of-pocket cash expense. | To satisfy the tax withholding requirements on the income recognized from the vested shares. |
| Employee Action | Requires an active decision by the employee to initiate the exercise and the "sell to cover" transaction. | Is often an automatic process set up by the employer's stock plan administrator at the time of vesting. |
Win the Tax Game with Consilio
Consilio Wealth Advisors offers fiduciary and wealth planning services to tech professionals. We specialize in navigating the complex tax and financial landscape of tech professionals, so we get it. We get YOU. We understand the unique compensation structures that come with working for tech giants, and we have over a decade of experience helping others like you build a wealth plan forward.
Looking for an outside expert opinion that can weigh in and help you understand your options? Give us a call! Reach out to us today to book a consultation on your wealth planning strategy!
Disclosures
The information provided in this article is for educational and informational purposes only and does not constitute investment advice and should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status, or investment horizon. You should consult your attorney or tax advisor.
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Consilio Wealth Advisors, LLC ("CWA") is a registered investment advisor. Advisory services are only offered to clients or prospective clients where CWA and its representatives are properly licensed or exempt from licensure.
