Venture-backed companies often grant Restricted Stock Units (RSU) to its employees as a form of incentive plan to encourage employees stay with the company for longer. The shares in RSU can be restricted (with no voting rights, for example) and only become available to employees after certain conditions are met, for example, the service duration of the employee.
Although no tax is charged to employees when the RSU are granted, tax and NIC are due when the shares become available to employees or vested. The “net proceeds” is treated as income, and is taxed with income tax and NIC. The NIC not only includes the usual employee NIC, but also the employer NIC, leading to potentially a total deduction of 70% for employees at certain income levels. This article will try to explain how one can lose 70% of RSU value to tax and NIC.
Employee total salary before RSU is £130,000
Salary £130,000, RSU Value £20,000
- RSU Value £20,000
- Deducting employer’s NIC @ 13.8% = £2,760
- Remaining £17,240
- Income tax @ 40% of Remaining = £6,896
- Employee NIC @ 2% = £344
- Total Tax and NIC = £10,000
- Net pay = £10,000
- 50% Tax and NIC paid
Employee total salary before RSU is £100,000
Salary £100,000, RSU Value £25,000
- RSU Value £25,000
- Deducting employer’s NIC @ 13.8% = £3,450
- Remaining £21,550
- Income tax @ 40% of Remaining = £8,620
- Extra tax of £4,310 (due to loss of personal allowance as income above £100,000)
- Employee NIC @ 2% = £431
- Total Tax and NIC = £3,450+£8,620+£5,000+£431=£17,500
- 70% Tax and NIC Paid
Employee total salary before RSU is £150,000
Salary £150,000, RSU Value £20,000
- RSU Value £20,000
- Deducting employer’s NIC @ 13.8% = £2,760
- Remaining £17,240
- Income tax @ 45% of Remaining = £7,758
- Employee NIC @ 2% = £344
- Total Tax and NIC = £10,862
- Net pay = £9,138
- 55% Tax and NIC paid
What about buying the restricted shares outright instead of receiving shares granted?
If the shares are bought outright, then only capital gains tax will be due when they are sold. The tax benefit of CGT at 20% is significant compared with the above 50%-70% tax. However, the disadvantage is the intrinsic risks associated with venture companies – they may not make it and the shares will be worth nothing.
On the other hand, venture company employers may not give employees options to buy the shares outright, or even more likely, employees did not expect such a high tax rate before being hit by it.