Restricted stock awards are a popular way for companies to offer equity-oriented executive compensation. Some businesses offer them instead of stock option awards. The reason- options can lose most or all of their value if the price of the underlying stock takes a dive. But with restricted stock, if the stock price goes down, your company can issue you additional restricted shares to make up the difference.
Restricted Stock - The Basics
In a typical restricted stock deal, you receive company stock subject to one or more restrictions. The most common restriction employees face is the requirement to fullfill work of duties through a certain date. If you leave before that date, you forfeit the restricted shares, which are usually issued at minimal or no cost to you. To be clear, restricted shares are shares that are transferred to you, however, until they become vested, you don’t actually own them.
Tax Rules for Stock Awards
What are the tax implications? Your restricted shares aren't considered taxable income until they are vested — meaning once your ownership is no longer restricted. After your shares are vested, 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%. You may owe an additional 3.8% net investment income tax (NIIT) as well as state income tax, so keep those in mind after you're fully vested.
Any appreciation after the shares vest is treated as capital gain. So, 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%, but you may still owe the 3.8% NIIT and possible state income tax.
Special Section 83(b) Election
What is a Section 83(b) election? This election grants an employee the option to pay taxes on the fair market value of their restricted stock award up front, rather than waiting until your shares are vested. 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 electing the special Section 83(b) is that, if held for more than a year, any subsequent appreciation in the value of the stock is treated as lower-taxed, long-term capital gain. Also, making this election can provide insurance against potential higher tax rates you may incur once your restricted shares become vested.
The downside of making this election is that the value is recognized as taxable income within 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 this election, you must notify the IRS either before the restricted stock is transferred to you or within 30 days after that date. Your VAAS Pro Consultant can help you with election details.
The tax rules for restricted stock awards are pretty straightforward. The major tax planning consideration is deciding whether or not to make the Section 83(b) election. Consult with us before making that call. We can