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Tax outcomes of restricted stock units can complicate returns

Facebook is a ubiquitous presence in Florida, across the country and around the globe. The buzz surrounding the company is its upcoming initial public offering, which is drawing significant investor interest. But there is an additional angle to the IPO, which concerns the method the company has chosen to compensate its employees.

It has been common for technology businesses to include stock options in an employee's compensation package. But in recent years there has been a trend towards using restricted stock units, which do not function like traditional stock options. As their name hints, RSUs are limited in an important way. They do not become stock until a specified "liquidity event" occurs, such as an IPO. At that time, however, an employee with a large number of accumulated RSUs can receive an influx of company stock. Failure to accurately report the gains associated with the stock can result in a tax audit from the Internal Revenue Service.

The reason why RSUs can be problematic from a tax perspective is the way the IRS categorizes them. Because they are part of an employee's compensation, the Tax Code views them as ordinary income in the year that they vest in an employee as actual shares of stock. But precisely because RSUs can gather until the determined liquidity event, an employee can have a significant spate of income all at once when the RSUs convert into stock.

To complicate matters, this "income" occurs entirely on paper. Employees have shares worth a certain amount of money, but have no cash deposited into their bank accounts. The IRS, however, still requires that the employee pay the tax on the realized gain from the receipt of the stock. And this tax bill may not be miniscule--the average Facebook employee will reportedly have to pay over $1 million to the IRS and state taxing agencies.

Therefore, employees may have to sell some of their shares to meet their tax obligations. Proper tax planning and accurate tax reporting are essential to avoid a tax controversy with the IRS.

Source: CNN Money, "Facebook employees face $4 billion tax bite," Stacy Cowley, May 9, 2012.

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