RSA Taxation
RSA taxation can be confusing, especially given how they are normally taxed is rarely what is done in practice. Here is what you need to know!
Tax Implications of RSAs
RSAs have somewhat unique tax dynamics in that how they are technically taxed practically never applies, because nearly all RSA grants are 100% early-exercised/purchased via an 83(b) election. As such, we detail below how taxation would work in the vast majority of circumstances; and provide an expandable box to learn more in the rare scenario where an 83(b) election is not made
RSA Taxation When an 83(b) Election is Made [Vast Majority of Circumstances]
RSAs are most commonly granted to founders and first employees shortly after the company is formed. At this stage of the company's life, the FMV is typically tiny (fractions of a penny) because the "company" is just an idea; nothing has been created so no value exists yet. This typically creates an attractive risk/reward to early exercise: the cost to pre-purchase 100% of a grant is typically less than $1,000 and if the company is successful the tax savings from early exercise can be much much larger. Tax-wise, if 100% of shares are 83(b) early exercised:
No taxation upon grant or when shares vest because taxation was elected up front via 83(b), even though that resulted in $0 of tax impact
If shares are sold in the future, they'd be subject to capital gains tax rules:
Short-term capital gain/loss if held less than 1 year prior to sale
Long-term capital gain/loss if held more than 1 year prior to sale
Potentially eligible for QSBS exclusion if they meet all the criteria (more details below)
RSA Taxation When an 83(b) Election is NOT Made [Rarely Occurs]
In the rare scenario that an RSA grant is not early exercised, then taxation would work as follows:
No taxation upon grant
Ordinary income tax when shares vest. Ordinary income is generated on the bargain element when shares vest. Tax withholding is also required (which can be a big challenge given shares are not liquid)
If shares are sold in the future, they'd be subject to capital gains tax rules. Just like RSUs, the cost basis of vested shares is the FMV on the vest date. If a sale occurs thereafter, it is subject to capital gains/loss tax rules
Unique Items and Special Situations
No Purchase Price Specified for the RSA Grant
If an RSA grant does not specify a purchase price per share, (1) You do not owe the company anything to purchase the shares, but (2) Since there is no purchase price, the entire value of the shares is considered taxable compensation income.
Presuming you file an 83(b) election on the grant, you'll owe income tax on 100% of the granted value. Your tax bill will likely be very minimal (e.g. less than $1,000) given that the RSA grant/83(b) election occurred very early in the company's life stage when the FMV is de minimis.
If an RSA grant is made in this manner, it could invalidate QSBS eligibility
Increased Likelihood of Qualifying for QSBS Exclusion
QSBS has a number of requirements that must be met to qualify for the tax exclusion. Due to when RSAs are granted and an 83(b) election is made, the shares will typically have increased odds that an eventual sale of shares will qualify for the QSBS exemption (by either meeting or increasing the odds of meeting, some of the key requirements):
Shares purchased when the company has less than $50 million of assets. Due to the early company life stage, shares via an RSA grant (with an 83(b) election) practically always meet this requirement
5 year holding requirement. Because an 83(b) election is almost always made for a RSA grant, the 5-year holding requirement for QSBS starts early (pretty much as early as possible). And given its typically in the very early stage of a company’s life, the time between exercise and a liquidity event (if one were to occur) is maximized, increasing the odds of meeting the 5-year requirement.
Note: The 5-year holding requirement is one of the most important QSBS requirements to meet, but there are also a number of others. For more information see: Qualified Small Business Stock (QSBS)
Taxation Examples
Background: Marina is a co-founder of Going Someplace, Inc., a newly formed C-corp. Marina was granted 3,000,000 RSAs in the company, vesting over 7 years, with a strike price of $0.0001 per share. Marina immediately purchases all of the shares with 83(b) election. Additionally:
3 years later, a tender offer occurs at $5.00 per share and Marina sells 100,000 shares
4 years after that (i.e. 7 years after the grant was made and the 83(b) election), the company is acquired for all cash at $7.00 per share
Taxation Rules & Requirements:
When the grant is made, there is no tax impact
When the 83(b) election is made, there is no tax impact because the purchase price is equal to the FMV (i.e. no bargain element exists)
When RSAs vest, there is no tax impact (because all the shares were pre-purchased via 83(b) election)
3 years later when 100,000 shares are sold during the tender offer for $5.00 per share, Marina will receive $500,000, and will owe long-term capital gains on all of it (since her tax basis in the stock is $0.0001). She will likely owe 20% federal long-term capital gains + 3.8% NIIT + state taxes (if applicable)
7 years later when the company is acquired, all of Marina's remaining shares (2,900,000) are sold for $7.00 per share. Marina will receive $20,300,000. If the shares qualify for the QSBS exclusion, the tax impact will be
The first $10 million of gains are excluded from federal taxation (QSBS exemption), as well as taxation in most (but not all) states
The remaining $10.3 million of will be subject to (most likely) 20% federal long-term capital gains + 3.8% NIIT + state taxes (if applicable)
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