Unfortunately, there is much confusion with restricted stock. For the most part, it is often mistaken for restricted stock units (RSUs). And while both are very similar, there are still important differences.
Restricted stock is where a company grants shares directly to an employee or contractor. But the person will not be able to sell any of the shares until they are vested. Often this means working for a company for a period of time or hitting certain performance goals.
How the Taxes Work
Now there is no tax recognized at the time of the grant. After all, you have no right to sell the shares.
But when the restricted stock vests, you will recognize income to the extent of the value of the shares minus any payment you made for them (although, usually a company does not require any payment). The tax rate will be at your ordinary rates (this is the same as for your wages, with the maximum federal rate at 39.6%).
Something else: Because you have ownership of the shares, you will receive any dividend payments and also have the right to vote on important corporate matters.
Ok, so let’s take an example: XYZ Corp. issues you 1,000 shares of restricted stock with a vesting period of four years. At the time, the stock price is at $10. But the company does not require that you pay for them.
A year goes by and you vest 250 shares. As of now, the stock price is $15. In other words, you will recognize income of $3,750 (250 shares X $15). If you are an employee, the employer will withhold federal and state taxes as well as employment taxes (Social Security and Medicare). The income will also be reported on your W-2.
However, if you are self-employed, then you will likely need to pay estimated taxes to avoid any penalties and interest. The company will then issue a 1099-MISC.
Once you own the shares, you can sell them any time. But of course, there are important tax consequences. First of all, you will be able to include the income in the cost of the shares (or “cost basis”).
Let’s continue our example: After a few months, you decide to sell 250 shares at $25 each or $6,250. In this case, your gain is as follows:
$6,250 gross proceeds from the trade
-$3,750 from the income recognized
Interestingly enough, it is common for people to forget this!
What’s more, the timing of the sale is also critical. If you sell the shares a year after the vesting, then you will be taxed at the long-term capital gains rates (the maximum is only 20%). Although, if sooner, the trade will be considered short-term and you will be taxed at your ordinary rates.
Finally, restricted stock has another valuable tax advantage. It’s known as the 83(b) election. For details on this, check out the following link.