Restricted stock awards are a popular way for companies to offer equity-oriented executive compensation (non-cash compensation offered to employees).
Some companies offer restricted stock as an alternative to stock option awards because they can lose most, or all, of their value if the price of the underlying stock takes a dive. However, if the stock price goes down with restricted stocks, some companies can issue their employees additional restricted shares to make up the difference.
Restricted Stock Basics
In a typical restricted stock deal, you receive a share of company stock, subject to one or more restrictions. To be clear, the restricted shares are transferred to you; you don’t technically own them without any restrictions until they become vested The most common restriction is that you must continue working for the company until a certain date. If you leave before then, you forfeit the restricted shares, usually issued at minimal or no cost to you.
Always familiarize yourself with your company’s restricted stock vesting schedule and restrictions, as these may vary.
Restricted Stock Tax Rules
What are the tax implications? You don’t have any taxable income from a restricted share award until the shares become vested — meaning when your ownership is no longer restricted. At that time, you’re deemed to receive taxable compensation income equal to the difference between the value of the shares on the vesting date and the amount you paid for them if anything. The current federal income tax rate on compensation income can be as high as 37%. It is important to note, that you’ll likely owe an additional 3.8% net investment income tax (NIIT), as well as state income tax.
Any appreciation after the shares vest is treated as a capital gain. If you hold the stock for more than one year after the vesting date, you’ll have a lower-taxed long-term capital gain on any post-vesting-date appreciation. The current maximum federal rate on long-term capital gains is 20%. Again, note, that you may owe the 3.8% NIIT, as well as state income tax.
Special Election Taxation
If you make a special Section 83(b) election, you’ll be taxed at the time you receive your restricted stock award instead of later when the restricted shares vest. The income amount equals the difference between the value of the shares at the time of the restricted stock award and the amount you pay for them if anything. The income is treated as compensation subject to federal income tax, federal employment taxes, and state income tax, if applicable.
The benefit of making the election is that it can provide insurance against higher tax rates that might be in place when your restricted shares become vested. Also, if you hold the stock for more than one year, any subsequent appreciation in the value of the stock is treated as a lower-taxed, long-term capital gain.
The downside of making the election is that you recognize taxable income in the year you receive the restricted stock award, even though the shares may later be forfeited or decline in value. If you forfeit the shares back to your employer, you can claim a capital loss for the amount you paid for the shares, if anything.
If you opt to make the election, you must notify the IRS either before the restricted stock is transferred to you or within 30 days after that date. The good news is we can help you with election details!