Good to Know
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 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.
The Bottom Line
This side-by-side comparison illustrates the contrasts between RSAs and RSUs.
|When are shares issued?||Immediately
|Restrictions on sale, transfer, gift, or encumbrance?||Yes
|Customary purchase cost of shares to employee||$0
or less than FMV
|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
|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
1 The specific tax strategy involved is the 83(b) election and it must be affirmatively and timely elected by the employee.
2 The 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.
3 The 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.
4 The 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.