About Restricted Stock Awards
How do Restricted Stock Award Plans work?
Once an employee is granted a Restricted Stock Award, the employee must decide whether to accept or decline the grant. If the employee accepts the grant, he may be required to pay the employer a purchase price for the grant.
After accepting a grant and providing payment (if applicable) the employee must wait until the grant vests. Vesting periods for Restricted Stock Awards may be time-based (a stated period from the grant date), or performance-based (often tied to achievement of corporate goals.)
Income Tax Treatment
Under normal federal income tax rules, an employee receiving a Restricted Stock Award is not taxed at the time of the grant (assuming no election under Section 83(b) has been made, as discussed below). Instead, the employee is taxed at vesting, when the restrictions lapse. The amount of income subject to tax is the difference between the fair market value of the grant at the time of vesting minus the amount paid for the grant, if any.
Special Tax 83(b) Election
Under Section 83(b) of the Internal Revenue Code, employees can change the tax treatment of their Restricted Stock Awards. Employees choosing to make the Special Tax 83(b) election are electing to include the fair market value of the stock at the time of the grant minus the amount paid for the shares (if any) as part of their income (without regard to the restrictions). They will be subject to required tax withholding at the time the restricted stock award shares are received. In addition to the immediate income inclusion, a Special Tax 83(b) election will cause the stock’s holding period to begin immediately after the award is granted.
With a Special Tax 83(b) election, employees are not subject to income tax when the shares vest (regardless of the fair market value at the time of vesting), and they are not subject to further tax until the shares are sold. Subsequent gains or losses of the stock would be capital gains or losses (assuming the stock is held as a capital asset). However, if an employee were to leave the company prior to vesting, he would not be entitled to any refund of taxes previously paid or a tax loss with respect to the stock forfeited.
Deciding Whether to Make a Special Tax 83(b) Election
Whether to make a Special Tax 83(b) election is an important tax and financial decision, and employees are urged to consult their tax advisers.
There are several potential advantages of making a Special Tax 83(b) election:
Establish cost basis now. By paying tax on the grant now, rather than when the shares vest, the current stock price will be established as the cost basis for the shares granted. When the shares do vest, no tax will be due until the shares are sold, regardless of how much the shares may have changed in value.
Control the timing of future income recognition. Gain (or loss) would be recognized only when the stock is actually sold and would not be triggered by the lapse of restrictions at vesting.
Capital gains treatment. Assuming the stock is held as a capital asset, future gains (or losses) would be taxed only as capital gains, and, therefore, would be subject to favorable capital gains tax rates.
There are also several potential disadvantages of making a Special Tax 83(b) election:
Falling share prices. If the stock price declined during the vesting period, there is a risk that more taxes would be paid based on the fair market value on the grant date than would have been paid at vesting.
Timing of tax payment. Since taxes are due when the award is granted, you will need to use other funds to pay the tax withholding obligation. Under normal tax treatment, you do not owe taxes until the grant vests and you could potentially use some of the shares vesting to cover your tax withholding obligation.
Paying Income Tax on Restricted Stock Awards
Depending on plan rules, individuals who decide not to make a Special Tax 83(b) election have two options to meet their tax withholding obligation due at vesting – net shares or pay cash.
Individuals who elect to net shares will have the appropriate number of shares withheld at vesting in order to cover their tax withholding obligation. They will receive the number of shares vested less the number of shares withheld for tax purposes.