Employee compensation is a major expenditure for most corporations; therefore, many firms find it easier to pay at least a portion of their employees' compensation in the form of stock. This type of compensation has two advantages: it reduces the amount of cash compensation that employers must pay out, and also serves as an incentive for employee productivity. There are many types of stock compensation, and each has its own set of rules and regulations. Executives that receive stock options face a special set of rules that restrict the circumstances under which they may exercise and sell them. This article will examine the nature of restricted stock and restricted stock units (RSUs) and how they are taxed.
What Is Restricted Stock?
Restricted stock is, by definition, stock that has been granted to an executive that is nontransferable and subject to forfeiture under certain conditions, such as termination of employment or failure to meet either corporate or personal performance benchmarks. Restricted stock also generally becomes available to the recipient under a graded vesting schedule that lasts for several years.
Although there are some exceptions, most restricted stock is granted to executives that are considered to have "insider" knowledge of a corporation, thus making it subject to the insider trading regulations under SEC Rule 144. Failure to adhere to these regulations can also result in forfeiture. Restricted stockholders have voting rights, the same as any other type of shareholder. Restricted stock grants have become more popular since the mid-2000s, when companies were required to expense
stock option grants .
RSUs resemble restricted stock options conceptually, but differ in some key respects. RSUs represent an unsecured promise by the employer to grant a set number of shares of stock to the employee upon the completion of the vesting schedule. Some types of plans allow for a cash payment to be made in lieu of the stock, but this type of plan is in the minority. Most plans mandate that actual shares of the stock are not to be issued until the underlying covenants are met.
Therefore, the shares of stock cannot be delivered until vesting and forfeiture requirements have been satisfied and release is granted. Some RSU plans allow the employee to decide within certain limits exactly when he or she would like to receive the shares, which can assist in tax planning. However, unlike standard restricted stockholders, RSU participants have no voting rights on the stock during the vesting period, because no stock has actually been issued. The rules of each plan will determine whether RSU holders receive dividend equivalents.
How Are Restricted Stock Taxed?
Restricted stock and RSUs are taxed differently than other kinds of stock options. such as statutory or non-statutory employee stock purchase plans (ESPPs). Those plans generally have tax consequences at the date of exercise or sale, whereas restricted stock usually becomes taxable upon the completion of the vesting schedule. For restricted stock plans, the entire amount of the vested stock must be counted as ordinary income in the year of vesting.