Restricted Stock

Critical Concepts #

1. RSAs (also known as restricted stock awards) are a form of compensation similar to RSUs.
2. Stock that is restricted is actually given to the recipient, but the recipient is not allowed to sell or transfer it until it has vested.

Vesting #

“Restricted” grants are subject to vesting schedules, which can be based on:

• Length of employment. These are time-based conditions, requiring you to work at the company for a certain period before vesting can occur.
• Performance goals. These are usually reserved for upper-management, tied to company-specific metrics or stock-market targets.

Even after they are vested, your company may impose other restrictions on transfers or sales, especially if the company remains private. However, as long as you continue to work at your company, you will not forfeit your grant, and it will not expire.

Example

When the market price of your company’s stock is $10, you receive 10,000 shares of restricted stock. When the grant vests, the stock price has fallen to $3. Your grant is then worth $30,000 before taxes.

As an alternative, if you were granted stock options with an exercise price of $10, at vesting the options would be worthless, as they would be underwater by $7 when the stock price is $3.

Taxes #

• How are RSAs taxed? Restricted stock is taxed when the stock is vested.
• What are you taxed on? Your taxable income is the market value of the shares at vesting.
• What type of income and how is it taxed? You have compensation income subject to federal and employment tax (Social Security and Medicare) and any state and local tax.
• Will any of that income be withheld? That income is subject to mandatory supplemental wage withholding. Withholding taxes (which will appear on your Form W-2)

Example

You receive 4,000 shares of restricted stock that vest at a rate of 25% a year, and the market price at grant is $5. The stock price at year one is $10 (1,000 x $10 = $10,000 of ordinary income), at year two $20 (1,000 x $20 = $20,000), at year three $30 (1,000 x $30 = $30,000), at year two $40 (1,000 x $40 = $40,000); the total is $100,000, each increment of which is taxable on its vesting date.

You sell all the stock three years after the last shares vest, when the price is at $100 ($400,000 for the 4,000 shares). Your capital gain is $300,000 ($400,000 minus $100,000), which is reported on your tax return on Form 8949 and Schedule D. If you hold the shares for more than one year after share delivery, the sales proceeds will be taxed at the long-term capital gains rate.

The Section 83(b) Election #

During the 30 days following the date of grant, you can make a Section 83(b) election with the IRS for restricted stock (but not RSUs). The 83(b) election involves paying taxes on the value of the stock at grant instead of vesting.

You sell all the stock three years after the last shares vest, when the price is at $100 ($400,000 for the 4,000 shares). Your capital gain is $380,000 ($400,000 minus $20,000), which is reported on your tax return on Form 8949 and Schedule D.

The election starts the capital gain holding period for all shares covered by the 83(b) election.

If you hold the shares for more than one year, the sales proceeds will be taxed at the long-term capital gains rate.

You should consider making an 83(b) election when you are confident that you will meet the vesting requirement and when the stock price on the vesting date is likely to be higher than it was on the grant date.

Example

Differences with Stock Options #

While stock options can fall “underwater” and lose all value when stock prices fall, restricted stock will retain some value even if a stock price drops dramatically.

Another major difference is that restricted stock is treated like any other issued and outstanding stock when it comes to entitlement to voting and dividend rights. The dividends from restricted stock may be distributed as cash when paid or may be accrued and paid only after the award vests completely.