Understanding the Key Differences Between Restricted Stock and Restricted Stock Units (RSUs)
When it comes to equity compensation, two types of restricted units—restricted stock and restricted stock units (RSUs)—are similar yet distinctive. Despite the misleading information found on sites like Quora, these two forms of equity share crucial differences. This article aims to demystify the differences between restricted stock and RSUs, illuminating the key distinctions and how they impact your financial situation and tax implications.
What is Restricted Stock?
Restricted stock is an actual share of stock given or sold to you as part of your compensation. Unlike regular stock, restricted shares are subject to certain conditions that prevent you from transferring or selling them. The company typically retains the right to reclaim the forfeited shares upon the occurrence or non-occurrence of specific events. For instance, you might be required to forfeit the stock if you leave the company within a specified period, or if the company’s earnings do not meet a certain threshold over a defined period.
Tax Treatment of Restricted Stock
The unique nature of restricted stock impacts how taxes are handled. When you receive the restricted stock, you are not taxed on its value. Instead, taxation occurs when the restrictions expire or when the stock becomes transferrable. At that point, you are taxed on the fair market value of the shares, less any purchase price, as regular income. Until the restrictions expire, you retain shareholder rights such as voting and dividend entitlements, although dividends are not treated as tax dividends.
Election for Accelerated Taxation
A unique feature of restricted stock is the ability to make an election under section 83b of the US tax code. By doing so, you can pay taxes on the value of the shares immediately upon receipt, even if they are subject to forfeiture. This can be advantageous when the value at the time of grant is low but is anticipated to grow substantially over time, converting the eventual gain from ordinary income to long-term capital gains.
What are Restricted Stock Units (RSUs)?
RSUs are not actual shares of stock but rather a form of deferred compensation. They represent a promise from your employer to pay you an amount of money measured by the value of a certain number of shares at a future date or upon a specified event. RSUs vest, i.e., become non-forfeitable, either at a pre-determined time or earlier than that.
Tax Implications of RSUs
The primary difference in tax treatment lies in the timing and nature of the compensation. Since RSUs are not subject to immediate tax when granted, there’s no obligation to report them as taxable income. Tax becomes due only when the RSU vests and is paid to you. Should the RSU be settled in shares, the recipient may receive the shares outright or have them settled in cash with some shares sold to cover withholding obligations.
No Section 83b Election for RSUs
Unlike restricted stock, you cannot make a section 83b election for RSUs. This is due to the deferred nature of RSUs, which are taxed when they vest and are paid, regardless of when or if the shares are actually issued. The payment upon vesting is the taxable event, not the RSU itself.
Additional Considerations
Various other differences exist between restricted stock and RSUs, such as vesting schedules, the issuance of actual shares versus cash settlement, and specific tax considerations.
While the distinction between restricted stock and RSUs may seem subtle at first, these differences can significantly impact your financial and tax situation. Understanding these nuances is crucial for making informed decisions regarding your equity compensation.
Whether it’s through restricted stock or RSUs, it’s always advisable to consult with a financial advisor or tax professional to navigate the complex world of equity compensation.