Executive Compensation—Restricted Stock

Good to Know

All that glitters is not gold.

-French Monk Alain de Lille, 1175

Assume your client just received a grant of Restricted Stock from their employer. Congratulations are in order, but before they go out and use some of that grant “money” to celebrate, let’s understand exactly what they received and when they can turn it into gold (monetize it). It turns out Restricted Stock comes in two distinctly different flavors—Restricted Stock Units and Restricted Stock Awards. The keys to knowing how and when your client can monetize restricted stock differ—at times dramatically—for each flavor, as summarized in the tables below.

Restricted Stock Awards (RSA)

An RSA is literally an immediate award of shares to an employee by their employer at the grant date. The employee becomes the legal owner of the shares when received—but with restrictions. For example, the employee may not sell, transfer, gift, or encumber the shares until they vest. Take a moment to know the key pros and cons below.

RESTRICTED STOCK AWARDS
Pros	Cons
Actual shares of stock are issued to employee shortly after or on the grant date—well before the shares vest. The employee can vote the non-vested shares. The employer may pay dividends on non-vested shares. Employers commonly—but are not compelled to—provide the RSA at no cost to the employee. Appreciation after the grant date may be taxed at long-term capital gain rates if holding period and other requirements are met.¹	The employee may not sell, transfer, gift, or encumber (e.g., use as collateral for a loan) the shares until they vest. Vesting usually occurs over a period of years or when specific performance goals are achieved. Non-vested shares may be forfeited if employment is terminated before vesting. Dividends received (if any) from non-vested shares are taxed as compensation income and are ineligible for long-term capital treatment.

Restricted Stock Units (RSUs)

In sharp contrast to an RSA, a grant of Restricted Stock Units RSU provides no shares to the employee at the grant date. Shares are distributed to the employee only when vesting is complete. Noteworthy pros and cons follow.

RESTRICTED STOCK UNITS
Pros	Cons
The employee will eventually receive the shares at the end of the successful completion of the vesting requirements. Restrictions generally do not apply to the shares when distributed to the employee when the shares vest. The employer may, but is not compelled to, pay additional “dividend-equivalent” compensation during the vesting period.	The employee receives no employer shares until the RSU vests. Vesting generally occurs over time or when specific performance goals are achieved. The employee generally forfeits the RSUs if they terminate employment within the vesting period or fail to fulfill the vesting requirements. Holders of RSUs have no voting rights and do not receive dividends until shares are delivered to the employee. The bargain element² is taxed as compensation income—not capital gains —when shares are issued.

The Bottom Line

This side-by-side comparison illustrates the contrasts between RSAs and RSUs.

Comparison and RSAs and RSUs
	RSA	RSU
When are shares issued?	Immediately Award Date	Delayed Vesting Date
Restrictions on sale, transfer, gift, or encumbrance?	Yes until vested	Same
Customary purchase cost of shares to employee	$0 or less than FMV	$0
Vesting	Period of years or reaching performance goal	Same
How is appreciation from grant date until vesting date taxed?	Capital Gain 83(b) election¹	Compensation Income Bargain Element²
How is bargain element taxed?²	Compensation Income	Same
When can employee vote the shares?	Grant Date	Vesting Date
Dividends paid on non-vested shares?	Yes³	No³

In closing, a grant of either an RSA or an RSU is a welcome opportunity to receive equity-based compensation. For many clients, the RSA provides more advantages (especially voting rights and the potential to reduce income taxes) than RSUs. However, when is it a bad day when your client receives additional compensation? Translation from the author’s grandfather, “never look a gift horse in the mouth.”⁴

Disclaimer

The information presented herein is provided purely for educational purposes and to raise awareness of these issues; it is not meant to provide and should not be used to provide legal, identity theft protection, investment, income tax, risk management, retirement, estate, or financial planning advice of any kind. An experienced and credentialed expert should be consulted before making decisions relating to the topics covered herein. There are variations, alternatives, and exceptions to this material that could not be covered within the scope of this blog.

¹ The specific tax strategy involved is the 83(b) election and it must be affirmatively and timely elected by the employee.

²The bargain element is the difference between the stock’s fair market and the amount the employee paid for the stock (if any) when the shares are issued. The bargain element is generally taxed at the issue date for RSAs (if 83(b) is elected) and at the vesting date for RSUs.

³The employer may pay dividends on non-vested RSA shares but not on RSUs. However, the employer may choose to pay additional compensation on RSUs in lieu of dividends.

⁴The phrase, “don't look a gift horse in the mouth” originates from 400 AD and refers to the practice of learning a horse’s general health by inspecting its teeth, usually when the horse was being sold.

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