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Global Tax Insights

Restricted Stock, Restricted Stock Units and Your Taxes

December 19, 2013

Which stock options are the best fit for top performers?

Corporations utilize a number of investment vehicles and rewards to incentivize their top performers and provide more varied compensation to their workforce. Stocks and investments are fairly common in the corporate world, and employees who reach certain levels with a company may be offered restricted stock or restricted stock units. Given the similarity in name, a common mistake is to view these investments as interchangeable. Both have a unique set of characteristics that investors should fully understand in order to maximize their function for tax planning purposes, as well as their treatment under the U.S. tax code.

Restricted stock traits

Restricted stock is typically reserved for those executives who have reached the upper echelons of their corporations. The stock holdings are non-transferable and also subject to forfeiture in the event of certain scenarios, ranging from termination of employment to the failure to reach certain performance benchmarks. The stock - which is tied to a graded vesting schedule in place for several years - is generally extended to executives that are privy to coveted knowledge about the company. As such, the stock is subject to insider trading regulations.

Restricted stock is popular with investors because existing tax laws enable them to make a Section 83(b) election. This election permits them to report the fair market value of their shares as ordinary income on the date that the shares are granted, rather than the date at which they become vested. This scenario can greatly reduce an employee’s tax liability, as stock prices at the time they are granted are typically lower than at the time of vesting. Should investors choose not to make the Section 83(b) election, their shares will be taxed at the time of vesting.

Restricted stock unit characteristics

RSUs bear a number of similarities to restricted stocks, but are not as “elite” with regard to the employees permitted to receive them. These stocks essentially represent an unsecured promise by the employer to grant a specific number of shares of stock to an employee after a pre-determined vesting schedule has been completed. RSUs generally allow for more flexibility and tax-planning opportunities among investors, because recipients typically have more authority over determining when they wish to receive the shares. Additionally, investors may have the option of receiving cash in place of stock units, or receive a combination of the two, depending upon the parameters of the plan.

Unlike restricted stockholders, however, investors holding RSUs are not extended shareholder voting rights during the vesting period because the shares have not yet been delivered. Further, RSU investors are not permitted to make an 83(b) election.

Which is the preferred option?

Both options carry measurable tax benefits and disadvantages, making it important for employees to determine their investing priorities before making a decision or a Section 83(b) election. Listed below are a few considerations to weigh prior to making a decision.

  • Dividends - Investors with restricted shares receive dividends both before and after vesting, while RSU holders are not entitled to dividends
  • Voting rights - Restricted stock holders maintain shareholder voting rights, while RSU holders are barred from making decisions about whether to take companies public or private
  • Foreign tax considerations - RSU holders on overseas assignments may enjoy more favorable taxation because of differences in when and how stock options are taxed

Our wealth, tax and advisory group can help you determine which employee incentives are right for your business and top performers.

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