What Is Restricted Stock?
Restricted stock refers to shares of stock that are subject to certain restrictions and conditions, such as a vesting schedule. Restricted stock is untransferable and becomes available to the employee after some conditions are met, often time related and governed by a vesting schedule.
The two main types of restricted stock are Restricted Stock Units (RSUs) and Restricted Stock Awards (RSAs). Restricted stock’s main difference from stock options is, upon issuance, the shares are owned by the employee and there is no ‘option’ to purchase the shares at a pre-determined price in the future.
Restricted stock must be traded within certain regulations, but it is not typically traded on an exchange like publicly traded stocks.
Here is an article on vesting schedules.
Who Gets Restricted Stock
Restricted stock typically is granted to executives at corporations. Given they are an outright award of equity ownership in a company, they are designed to motivate executives by allowing them to benefit in an increase in stock price in the future. It can also be granted to employees at various levels within a company.
Here is an article about employee stock purchase plans.
How Restricted Stock Works
Restricted stock is a simple way a company can grant shares to employees. The reason it is called ‘restricted’ stock is because there are restrictions on when the employees are issued the shares. The issuance is typically subject to a vesting schedule, which essentially means the employee needs to stay at the company for a certain amount of time before they receive the shares.
Vesting and Restricted Stock
Like options, restricted stock can also be subject to vesting, which is when the restricted stock holder fulfils certain conditions in order to be issued the stock. In most cases, vesting is based on time spent at a company and is governed by a vesting schedule. Vesting can also be tied to other performance metrics.
Restricted Stock Units (RSUs)
Restricted stock units (RSUs) are common stock that is granted to an employee which will be issued at a future date. RSUs are often settled in cash or company stock at the end of the vesting period.
The key to understanding RSUs is to keep in mind the shares will be owned in the future, and not when the RSUs are granted. RSUs are different than options because the employee does not need to purchase the shares when they vest.
Here is an article that goes more into RSUs.
Restricted Stock Awards (RSAs)
Restricted stock awards (RSAs) are shares given to employees at a company on the day the grant is given. In other words, the employee owns the stock of the RSA the day it is issued to the employee. However, in certain circumstances the employee still may have to purchase the shares in the future, which is why they are considered ‘restricted’. In some cases, they can also be subject to certain restrictions and conditions, such as a vesting schedule.
The result of the employee owning the stock immediately gives them voting rights, which is a difference between incentive stock options and RSUs.
Here is an article on RSAs.
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The Difference between RSUs and RSAs
The two variations of restricted stock include restricted stock units and restricted stock awards. They are similar in many ways, except for two major differences below:
- RSUs represent a promise made by an employer to an employee that they will own common stock in the future if certain requirements are met. RSAs, however, are owned by the employee on the date they are issued.
- RSAs give the employees voting rights. RSUs do not give employees voting rights, since the employee doesn’t ‘own’ the stock when the RSU is issued. However, voting rights associated with restricted stock can vary depending on the terms of the grant.
Here is an article on further differences between RSUs and RSAs.
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Restricted Stock vs. Stock Options
Restricted stock and stock options are both mechanisms for company’s to compensate employees with their own stock. The fundamental difference between the two is restricted stock is issued to an employee once certain criteria is achieved. Stock options, however, give an employee the option to buy stock in the future at a predetermined price, known as the exercise price.
For example, if Ray receives restricted stock from his company that vests in one year and Anna receives stock options from her company that vests in one year, Ray will automatically be issued the shares after one year (assuming he remains at the company for over one year) and Anna will be given the option to buy the stock at the exercise price after one year (assuming Anna is still at the company).
Some of the key terms that differentiate stock options from restricted stock are:
- Exercise Price: The exercise, also known as the strike price, is the fair market value of the stock when a stock option is issued. This is the price at which the employee can purchase shares in the future. RSUs do not have an exercise price since they are issued to the employee without requiring a purchase.
- Exercise Method: The exercise method is the way an employee pays for the purchase of the option shares in the future. This can include cash and stock swaps. Given RSUs are not purchased by the employee, there is no need for an exercise method.
- Expiration Date: Stock options have an expiration date since an employee needs to proactively elect to purchase their shares at the strike price. RSUs do not expire since they are issued once the employee is vested.
Incentive stock options (ISOs) and nonqualified stock options (NSOs) are two examples of stock options used by companies. Here is an article on Incentive Stock Options. Here is an article on Nonqualified Stock Options.
How To Sell Restricted Stock
Restricted stock is typically issued to executives that are ‘in the know’ of companies. For this reason, it is regulated by the SEC and an employee with restricted stock is subject to insider trading laws. It is important to keep these in mind when considering how to sell restricted stock.
Below are steps to take to sell restricted stock:
- Step 1: Comply with the SEC holding period requirements.
- Step 2: Make sure you follow the federal reporting requirements.
- Step 3: Make sure you know the amount of stock you can sell in a three-month period.
- Step 4: Remove the stock legend by contacting the transfer agent at the company that issued the stock.
- Step 5: Execute a normal brokerage transaction.
- Step 6: Notify the SEC with required filings.
Here is an article on how to sell restricted stock.
If are thinking of selling your restricted stock, it is important to consult an Employee Benefits Lawyer to make sure you don’t make any mistakes.
Restricted Stock Tax
Restricted stock is taxed differently than options, which typically have tax liability triggered by an exercise date or event. Restricted stock normally becomes taxable when the vesting schedule is complete and the stock counts as ordinary income. Yet, there can be different tax treatment depending on the type of restricted stock and the specific circumstances of the grant.
The amount that needs to be reported on your taxes is the fair market value of the stock minus the purchase price, which may be zero for restricted stock since you likely don’t purchase the stock, like you do with options. If the shareholder holds on to the stock and sells it at a later date, then they may also be liable to pay capital gains tax, which would be the difference in stock price from the vesting date to the sale date.
Here is an article about capital gains tax.
For example, if Ray was issued RSUs that fully vested in 2020 and were worth $10,000, Ray would need to report the ordinary income of $10,000 to the IRS for the year 2020. If Ray decided to hold (not sell) $5,000 worth of shares and they increased in value to $7,000 in the same year before he sold them, then Ray would be liable to pay capital gains tax on $2,000 ($7,000 - $2,000).
Section 83(b) Election
Restricted stock shareholders are allowed to report the fair market value of the stock upon grant as ordinary income, as opposed to when they are vested. This means the shares will be taxed at the capital gains rate. This election can greatly reduce tax liability.
Here is an article on Section 83(b) Election.
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