Restricted Stock: A Comprehensive Guide
Welcome, everyone. My name is Tan, and I am an independent CERTIFIED FINANCIAL PLANNER™ practitioner at TAN Wealth Management. Today’s educational video is on restricted stock.
What is restricted stock?
•Restricted stock is equity compensation. Restricted stock is a promise from the company to you stating the company will give you X number of shares if you satisfy their vesting conditions. When your employer gives you restricted stock, you don’t actually receive the employer’s stock.
•The word “restricted” means there are requirements you have to meet. It could be based on the length of employment or performance goals. One restricted stock represents one share of the actual employer’s stock.
•With restricted stock, no shares are issued to you at grant. The shares are delivered to you at vesting, and that is taxable supplemental income to you. Restricted stock is always worth something unless the stock price drops to $0. For example, the company grants you 1,000 restricted stock. At vesting, the stock price is $500 per share. 1,000 shares X $500 = $500,000.
Grant Date(s)
•There is no taxable event on the grant date unless you make an 83(b) election, and we will cover 83(b) election later in the video.
•The employer grants you the award to receive restricted stock. This means the employer promises you X number shares of the employer’s stock in your brokerage account if you meet certain requirements, such as staying employed with the company for 3 years.
•It’s a future promise from the employer to the employee.
•No tax liability because if you did not meet the requirements, could be based on performance goals and/or stay employed to a certain date, you will receive nothing.
•The restricted stock has a substantial risk of forfeiture.
•What is a substantial risk of forfeiture? “Property is subject to a substantial risk of forfeiture if...there is a substantial possibility that the property will be forfeited if the condition does not occur.” It means there is a possibility you will get nothing.
(Source: Nonqualified Deferred Compensation Audit Techniques Guide)
•For restricted stock, the stock price matters on the grant date and vesting date because you can make an 83(b) election and get taxed on the grant date instead of the vesting date.
Vesting Period
•The period between the grant date and the vesting date is considered the vesting period, or you can call it the waiting period.
•Restricted stock units and restricted stock are different.
•During the vesting period, restricted stock units have no shareholder voting rights and normally do not receive dividends.
•With restricted stock, during the restricted period/vesting period, dividends are paid, and you have voting rights.
•If the company pays dividends on outstanding shares, dividends may be deferred for additional shares or cash on the vesting date. It’s in the plan agreement if the company pays dividends equivalent. You can also check with your human resources department.
•Restricted Stock Units ≠ Restricted Stock
Vesting Schedule
•Cliff Vesting: You receive all the shares at once, such as you receive all the shares in 3 years.
•Graded Vesting: You receive shares at regular intervals until you receive all the shares.
•Hybrid of a Cliff and Graded Vesting: A combination of some shares upfront then shares at regular intervals until you receive all the shares.
Example of Cliff Vesting:
In 2020, your employer grants you 1,000 restricted stock units or restricted stock, and it will vest in 3 years, which is 2023.
0 share vest in 2021.
0 share vest in 2022.
1,000 shares vest in 2023.
Example of Graded Vesting:
In 2020, your employer grants you 1,000 restricted stock units or restricted stock, and it will vest 25% annually.
250 shares vested in 2021.
250 shares vested in 2022.
250 shares vested in 2023.
250 shares vested in 2024.
Example of a hybrid of a cliff and graded vesting.
In 2020, your employer grants you 1,000 restricted stock units or restricted stock, and it will vest in a year at 25% in year 1, 25% in year 2, and 50% in year 3.
250 shares will vest in 2021.
250 shares will vest in 2022.
500 shares will vest in 2023.
How to estimate your restricted stock units (RSUs) and restricted stock value?
•For public companies, you can multiply your number of shares times the current stock price.
•For private companies, you can multiply your number of shares times the latest round of funding or available price.
•I normally don’t like to incorporate the values of the restricted stock units and restricted stock in my clients’ financial plans because the restricted stock units and restricted stock might not vest. Therefore, the clients will get nothing. If they like, I can always show them the difference between incorporating the unvested shares and without the unvested shares in their financial plans.
Internal Revenue Code Section 83(b) election
What is an Internal Revenue Code Section 83(b) election?
•An 83(b) election is a provision that allows you to pay taxes on the fair market value of the stock based on the grant date instead of the vesting date.
•You cannot make an 83(b) election on restricted stock units.
•You can make an 83(b) election on restricted stock.
•For restricted stock, when you make an 83(b) election within 30 days from the date of grant, you can recognize ordinary income on the value of the stock based on the grant date instead of the vesting date.
•Restricted stock can be taxed on the value of the shares at the grant date instead at the vesting date because they are considered "property" within the Internal Revenue Code Section 83.
•You do NOT have this option with restricted stock units because they are NOT considered "property" within the Internal Revenue Code Section 83.
•This is directly from the IRS website, “Restricted Stock Units are not considered property for purposes of IRC §83 since no actual property has been transferred, and therefore an IRC §83(b) election cannot be made with respect to the grant of a Restricted Stock Unit.”
(Source: IRS - Stock Compensation Audit Techniques Guide)
An advantage of making an 83(b) election
A potential to save money in taxes assuming the stock price will increase from the grant date to the vesting date, and you also take into consideration the opportunity cost of the tax paid on the grant date. I say “potential” because we do not know what the stock price will be. Being taxed at long-term capital gains tax rates instead of ordinary income tax rates on the gains from the grant date to the vesting date, as long as the holding period is over a year.
5 disadvantages of making an 83(b) election:
1. Available cash: You have to find available cash to pay for the taxes when making an 83(b) election. Remember that you pay tax in the year the restricted stock is granted to you when you make an 83(b) election.
2. Risk of forfeiture: You might forfeit the tax paid. Be careful when making 83(b) election because you pay the taxes on the fair market value of the stock at the grant date, and your stock might not vest. You didn’t hit your goals, or you left the company before the shares were vested. You have to be sure the restricted stock will vest if you are going to make an 83(b) election because you might be in a long vesting schedule and/or the target performance is not easily achievable if the vesting requirement is based on job performance. Thus, it’s possible that your stock might not vest.
On the IRS website, the IRS gives an example (page 8 of 11, example 6) where an employee made an 83(b) election and included the supplemental wage in 2012. In 2013, the employee was terminated and “is not entitled to a deduction or credit for taxes paid as the result of filing the § 83(b) election or the subsequent forfeiture of the property.” Which means the employee paid tax on the stock, the stock did not vest, and the employee cannot get a tax credit or tax deduction for the tax paid.
(Source: IRS - 83(b) election)
3. Pay more taxes: You could pay more in taxes because the stock price at the vesting date is lower than at the grant date. Thus, you pay more in taxes.
4. Opportunity cost: The opportunity cost of the tax paid. If you have to wait 4 years in order for the restricted stock to vest, that is 4 years of potential growth in the stock market.
5. No control of the stock: Although you paid taxes on the value of the stock at the grant date, you don’t have control of the stock until it’s vested.
Examples of advantages and disadvantages of making an 83(b) election:
Apple granted 300 shares of restricted stock to Luna in 2016.
The 300 shares vested in 2020.
Luna sold all of her Apple shares on the vesting date, which is in 2020.
Advantages of making an 83(b) election:
In 2016, the stock price at the grant date was $300, and Luna made an 83(b) election.
In 2020, the stock price at the vesting date was $340.
The sold price was $340 because she sold all of the shares as soon as she received them.
300 shares X $300 = $90,000 of supplemental wage for the 2016 tax year.
($340 sold price - $300 cost basis) X 300 shares = $12,000 of long-term capital gain for the 2020 tax year.
Disadvantages of making an 83(b) election:
In 2016, the stock price at the grant date was $300, and Luna made an 83(b) election.
In 2020, the stock price at the vesting date was $200.
The sold price was $200 because she sold all of the shares as soon as she received them.
300 shares X $300 = $90,000 of supplemental wage for the 2016 tax year.
($200 sold price - $300 cost basis) X 300 shares = $30,000 of long-term capital loss for the 2020 tax year.
If Luna did not make an 83(b) election, she would save money in taxes. We should also consider the opportunity cost of the money she used to pay the taxes in 2016. That money could have been in the stock market and compounded for 4 years (2020 - 2016).
Should you make an 83(b) election?
It depends on a lot of moving variables, such as:
•What is the historical company stock price?
•What is your outlook on your company?
•What type of stock is it? You have to do a stock analysis of your company stock.
•How much is the tax withholding?
•Do you have the money to pay for the tax withholding?
•What can you do with the tax withholding money if you did not make an 83(b) election?
•What is the opportunity cost on the money you use to pay for the tax withholding?
•How long is the vesting period?
•And many more.
Review of IRC 83(b) election:
•You get taxed on the grant date at ordinary income tax rates. This will be your cost basis for the employer’s stock.
•You will get tax again when you sell the employer’s stock. The tax will be the difference between the cost basis and the sale price. Short-term or long-term holding period, gain or loss, depends on how long you hold the employer’s stock and the price you sold the employer’s stock.
•Here is a direct quote from the IRS website on IRC §83(b). ”An election pursuant to IRC §83(b) allows a recipient of restricted property to be taxed when the property is transferred instead of when the property actually vests (at a later date when the value may be higher). The election must be made no later than 30 days from the date the property is transferred to the service provider, with no extensions. Generally, such elections are handled through the employer’s payroll department.” (Source: IRS - Stock Compensation Audit Techniques Guide)
Dividends
How do I get taxed on the dividends from restricted stock?
•For restricted stock, during the vesting period, if the company pays dividends or dividends equivalent, the dividends will be reported as wages on your W-2 unless you make an 83(b) election. (Source: Schwab - RSUs Essential Facts)
•According to the IRS website, “if an employee or independent contractor receives dividends or other income from substantially non-vested restricted stock, the amounts are considered additional compensation to the individual and must be included in income, are subject to employment taxes, and may be deductible by the corporation. However, if the employee makes an election pursuant to IRC §83(b), the dividends are treated as dividend income rather than compensation. Once the restricted stock award vests, the dividends are treated as dividend income rather than compensation.”
(Source: IRS - Stock Compensation Audit Techniques Guide)
•Dividends on restricted stock are reported on your W-2 as wages and are not eligible for the lower tax rate on qualified dividends until after vesting, unless you made a Section 83(b) election at grant.
•If you made an 83(b) election at grant, the dividends could qualify for the lower tax rate on qualified dividends.
Vesting Date(s)
•This is a taxable event.
•Shares or cash equivalent are deposited in your account on the vesting date.
•When the restricted stock units and/or restricted stock vested, the employer’s stock is deposited in your account, or the company can deposit cash in your account that is equivalent to the shares fair market value.
•You can look in your plan agreement or ask your human resources department for more details on your specific plan.
•Your taxable income is based on the fair market value of the shares at vesting minus any cost you paid to acquire the shares, and it's subject to supplemental wage withholding, which includes Social Security tax (up to the yearly maximum which is $137,700 for 2020 tax year), Medicare tax, federal tax, state tax, and local tax if any.
(Source: SSA - Fact Sheet)
•Here is the formula: Number of Vested Shares x Fair Market Value of the Stock at the vesting date = Supplemental wage reported on W-2.
•The tax withholding may be in the form of employer’s shares or cash to cover the taxes.
•Restricted stock units and restricted stock are taxed as supplemental wages as soon as they become vested.
•If you keep the shares, you are entitled to voting rights and dividends, if any.
•The employer’s shares are yours, and you can do whatever you want as long as there are no other restrictions. You can sell some or all of the employer’s shares.
•Normally, vesting stops when you are terminated from your job and accelerated when you are deceased, become disabled, or retired. You want to truly understand your plan agreement.
•You should read your plan document and ask your human resources department about the provisions. What happens if you become disabled, retire, die, or get terminated during the vesting period? You want to know the provisions to help you with your financial planning.
•I have clients that have asked me, “Tan, I have restricted stock units or restricted stock that vest annually, and I don’t know why I keep getting taxed on it even though I did not sell it.” I tell them because the restricted stock units and restricted stock are taxed on the vesting date. There will be another taxable event when they sell their employer’s stock.
•From Cornell Law School, “wage income recognized on the lapse of a restriction on restricted property transferred from an employer to an employee” is considered supplemental wage payment.
(Source: Cornell Law)
Internal Revenue Code section 409A:
•What is Section 409A? ”Section 409A was added to the Internal Revenue Code by section 885 of the American Jobs Creation Act of 2004. Section 409A generally provides that unless certain requirements are met, amounts deferred under a nonqualified deferred compensation plan for all taxable years are currently includible in gross income to the extent not subject to a substantial risk of forfeiture and not previously included in gross income.”
(Source: IRS - IRC Section 409A)
•This is saying when the restricted stock units and restricted stock vested, the employer’s stock is yours, and you do not have the risk of losing the employer’s stock. Therefore, the fair market value you receive will be included as income to you.
•For example, Luna works at Apple. She looks at her My Stock Plan, and 300 shares are expected to vest in 2020.
In 2020, Apple share is at $340 per share.
300 shares X $340 per share = $102,000 reported as supplemental wage to Luna.
The $102,000 from the vested stock is in addition to the other benefits she receives from Apple, such as her salary, 401(k) matching contribution, Health Savings Account (HSA) matching contribution, Employee Assistance Program (EAP), et cetera.
Tax withholding methods starting with the highest risk due to a concentrated stock position.
•Cash Exercise or Cash Transfer: You give your employer the money to pay for the tax withholding. All of the vested shares will be deposited into your brokerage account.
•Net Share Settlement, Share Surrender, Share Withholding, Net Share Issuance, or Net Settlement: Your employer will keep shares equal to the tax withholding, then the remaining shares will be deposited to your brokerage account.
•Sell to Cover or Selling Shares: The plan will sell enough shares to cover the tax withholding then the remaining shares will be deposited to your brokerage account.
•Same Day Sale: The plan will sell all of the shares on the vesting date. After subtracting the tax withholding, the net cash will be deposited to your brokerage account.
How will Luna cover her taxes?
Here’s the background:
Apple promised Luna 300 Apple shares in 2020.
In 2020, Apple share is at $340 per share.
300 shares X $340 per share = $102,000 reported as supplemental wage to Luna.
Let’s assume Apple will withhold 22% for taxes which is $102,000 X 22% = $22,440 or 66 shares ($22,440 / $340).
An example of cash exercise:
Luna will pay $22,440 to Apple for the tax withholding, and 300 shares will be deposited to Luna’s E*TRADE account.
An example of net share settlement:
The plan will withhold 66 shares for tax withholding.
234 Apple shares are transferred to Luna’s E*TRADE account.
An example of sell-to-cover:
The plan will do the calculation and sell enough shares to cover the 22% tax withholding.
22% of 300 shares are 66 shares.
The plan will sell 66 shares for tax withholding.
234 Apple shares are transferred to Luna’s E*TRADE account.
An example of same-day sale:
The plan will sell 300 Apple shares which valued at $102,000
The plan will withhold 22% for tax withholding, which is $22,440.
$79,560 in cash will be transferred to Luna’s E*TRADE account.
Stock Swap
•If the plan allows, you can use your existing employer’s stock to exercise a stock option from your employer.
• For example, you own your employer’s stock through vested restricted stock units and/or restricted stock. You also have incentive stock options (ISOs) in-the-money you want to exercise. The plan will do that calculation to let you know how much cash you need to pay to exercise the ISOs or swap X number of shares of the employer’s stock to exercise the ISOs. You can pay in cash or the employer’s stock. It’s up to you.
Why do a stock swap?
1. You don't have the money to exercise the stock option.
2. You want to minimize the number of shares of the employer's stock.
Why not do a stock swap?
1. Keeping track of the cost basis, gains, bargain element for calculating the alternative minimum tax (AMT), and dates of acquired shares from different batches and types of shares can be complicated.
2. The tax implications on stock swap are taxed differently depending on what you are swapping the existing employer’s stock for. Are you swapping the existing employer’s stock with non-qualified stock options (NQSO) or incentive stock options (ISOs)?
Estimated tax due
•You can estimate how much the tax due is by multiplying the number of shares times the market value of the stock at the vesting date then multiplying it by your estimated tax rate to get the estimated tax due.
•Number of shares X market value of the stock at the vesting date = supplemental wage.
•Supplemental wage X your estimated tax rate = estimated tax due
•If you want to know what the shares are for tax withholding, just divide the tax due by the market value of the stock at the vesting date equal to the number of shares needed for tax withholding.
•We are continuing from our example of Luna.
300 shares X $340 per share = $102,000 is the supplemental wage to Luna.
$102,000 X 22% assumed Luna’s tax rate = $22,440 estimated tax due.
$22,440 / $340 = 66 shares for tax withholding.
•Please be advised that when Luna does her taxes in 2021 for the 2020 tax year, she could receive some money back because she overpaid in taxes, or she could pay more in taxes because she did not pay enough taxes.
Sell Date(s)
•This is a taxable event.
•Any price change in the employer’s stock price after the vesting date is treated as capital gain or loss.
•Long-term or short-term depends on the holding period, which is the difference between the share acquired date to the share sold date.
•Short-term is considered 1 year or less, which is 365 days or less. The short-term holding period is taxed at ordinary income tax rates.
•Long-term is considered more than 1 year, which is more than 365 days. The long-term holding period is taxed at long-term capital gains tax rates.
What should I do after my restricted stock units and/or restricted stock vested?
•If you hold your restricted stock units and/or restricted stock after it's vested, it's like you just bought your employer’s stock at the current price. If you receive a bonus, will you take that money and buy your employer’s stock in your brokerage account?
•Why do employees want to hold onto their employer’s stock after it vests? The employees do not want to miss out on the employer’s stock appreciation. If they sell the employer’s stock and then the employer’s stock keeps going up, they will regret selling the employer’s stock.
• If you are going to keep your employer’s stock, maybe you should have no more than 10% of your overall investable assets in your employer’s stock.- For example, if you have $1,000,000 of investable assets, no more than 10%, which is $100,000, should be in the employer’s stock.
•For conservative risk tolerance investors, it’s good to sell the vested shares.
•For aggressive risk tolerance investors, they can sell half of the vested shares and keep the remaining half, so they don’t feel like they are missing out if the employer’s stock price increases in the future or keep all the vested shares and build a portfolio around the employer’s stock.
•These are just examples, and you can do what you like because it’s your money and you worked hard for it.
•If you keep the employer’s stock, you should know you are exposed to systematic risks and unsystematic risks. I created an educational video on “Why You Should Be Cautious When Investing In Individual Stocks,” so investors can learn more about holding individual stocks.
If you sell the employer’s stock, you should understand your tax liability.
•If you received the shares at $340 per share, and you sold it for more than $340 per share, you have a capital gain.
•If you sold the shares for less than $340, you have a capital loss.
•If you purchased the shares on 6/15/2020 and sold it on 6/15/2021, do you have a short-term or long-term holding period? Short-term because it’s exactly 1 year. I have seen a lot of financial advisors, and investors make this mistake all the time.
•Here is a direct quote from the IRS website. “If you hold the asset for more than one year, your capital gain or loss is long-term. If you hold the asset one year or less, your capital gain or loss is short-term. To figure the holding period, begin counting on the day after you received the property and include the day you disposed of the property.”
(Source: IRS - Reporting Capital Gains)
We are continuing from the example of Luna working at Apple.
Grant Date:
•This is not a taxable event.
•Apple granted 300 restricted stock units or restricted stock to Luna, and it vested on 6/1/2020.
Vesting Date:
•This is a taxable event.
•300 shares X $340 per share = $102,000, which is the supplemental wage to Luna.
•She acquired the shares on 6/1/2020.
Sell Date:
Scenario 1:
•This is a taxable event.
•Luna sold all her shares on 7/1/2020 at $400 per share.
•$400 purchased price per share - $340 cost basis = $60 gain.
•$60 gain X 300 shares = $18,000 gain.
•The holding period is short-term, and it will be taxed at ordinary income tax rates.
•$18,000 gain X 37% assumed tax rate = $6,660 tax due.
Scenario 2:
•This is a taxable event.
•Luna sold all her shares on 8/1/2021 at $400 per share.
•$400 purchase price per share - $340 cost basis = $60 gain.
•$60 gain X 300 shares = $18,000 gain.
•The holding period is long-term, and it will be taxed at long-term capital gains tax rates.
•$18,000 gain X 20% assumed tax rate = $3,600 tax due.
The difference in tax between short-term of $6,660 and long-term of $3,600 is $3,060.
I choose a 37% tax rate for short-term holding period and 20% tax rate for long-term holding period because I just pick the highest tax rate for ordinary income tax rate and long-term capital gains tax rate for simplicity.
Long-term capital gains tax rates are lower than ordinary income tax rates, but it could change in the future.
Avoid insider trading with a Rule 10b5-1 Trading Plan.
•If you are executives of public companies and have access to material non-public information (MNPI), you want to have a plan on how you will sell your employer’s stock after it vests, so you are not accused of insider trading. One solution is to set up a Rule 10b5-1 Trading Plan which is a prearranged trading contract you file with the SEC to let them know how you will sell your employer’s stock when a condition you set is met, such as 25% of my holding on the last trading day of the year. You set the condition(s) however you want as long as it’s clear to the SEC on how you are doing it.
(Source: SEC - Rule 10b5-1 Trading Plan)
(Source: Harvard Law)
•You want to work with a financial planner to determine when you want to sell your employer’s stock then talk to your custodian firm to set up a Rule 10b5-1 Trading Plan.
•For high-level executives, your financial planner will work with your attorney and accountant to make sure everyone is working together to give you the proper recommendations, such as, do they “qualify as an executive under the section 16(b) of the Securities Exchange Act of 1934.” If so, there are rules they have to follow.
(Source: IRS - Stock Compensation Audit Techniques Guide)
What you should know about restricted stock units and restricted stock plans.
•You should really understand your plan.
•How many shares you will receive, by when, and what are the restrictions?
•What are you going to do once the shares are vested?
•How are you going to pay for the tax withholding? Are you going to tell your employer to withhold the shares or give the employer money for the tax withholding?
Questions to ask your employer so you can truly understand your restricted stock units and restricted stock plans.
•What is my vesting period?
•Is it based on how long I have to be with the company or based on my performance or both?
•When and how can I be fully vested?
•What happens if there are major company events like a merger or acquisition?
•What happens if I were to leave or lose my job, become disabled, die, or retire?
•What are the tax withholdings?
•Can I increase or decrease the tax withholding?
•Do I have restricted stock units and/or restricted stock?
•When the shares are vested, how can I have access to it?
•If the company pays dividends, do I get it, and how does it work?
•Can I designate a beneficiary?
•Am I expected to receive more restricted stock units or restricted stock in the future? If so, how many shares or dollar value?
•How can I get more restricted stock units or restricted stock?
Your employer might tell you to read the plan agreement, and you want to tell them that you read the plan agreement, and you want to confirm with them. If your employer cannot answer the questions, ask them who can?
When you sell the stock, ask a qualified tax preparer if you need to file Form 8949 and Schedule D on your tax return. Chances are, you do have to file it.
(Source: IRS Form 8949)
Some restricted stock units and restricted stock plans let you defer the delivery of the shares so you can defer ordinary income tax. You cannot defer the taxes if the shares are delivered to you.
Choices you need to decide to optimize your restricted stock:
1. Are you going to make an 83(b) election?
2. How are you going to pay for the tax withholding at the grant date if you make an 83(b) election or not make an 83(b) election, and pay the tax withholding at the vesting date?
3. Are you going to keep the employer’s stock after it vested?
4. When are you going to sell it?
5. What are you planning to do with the money after you sell the employer’s stock?
Tracking your restricted stock units and restricted stock is key.
•You need to track each restricted stock unit and restricted stock lot.
•How many shares will you receive, when, and what is the estimated dollar amount?
•What is the total supplemental wage to you, and what are the tax implications?
•When will each restricted stock unit and restricted stock lot be considered long term for the holding period?
•What is the total gain or loss once you convert the restricted stock units and restricted stock into cash?
Frequently asked questions on restricted stock units (RSUs) and restricted stock.
How can I maximize my restricted stock units and/or restricted stock?
•If you want to maximize your restricted stock units and/or restricted stock, you need to have a plan in advance with different alternatives, then pick the best alternative.
Here are some questions to assist you in making your decision.
•Do I truly know how my restricted stock units and/or restricted stock work?
•What are the provisions and restrictions on my restricted stock units and restricted stock?
•Once my restricted stock units and/or restricted stock are vested, are there any restrictions or provisions?
•How am I going to pay for the tax withholding?
•What am I going to do after my restricted stock units and/or restricted stock vest?
•How will my restricted stock units and/or restricted stock incorporate with my financial plan?
What are the top 3 things to love about restricted stock units (RSUs) and restricted stock?
•Receiving restricted stock units and restricted stock makes you happy because you received something from your employer. You feel more valued and appreciated. You will want to work harder to get more.
•Vested restricted stock units and restricted stock increase your net worth.
•Restricted stock units and restricted stock are simple to deal with because you have a limited amount of planning you can do compared to other complex stock options, such as incentive stock options (ISOs).
What are my restricted stock units and/or restricted stock cost basis, and what happens to the shares my company withholds for taxes?
•Let me explain this question by giving you a scenario.
•You received 4,000 shares at vesting, and the company withholds 22% which is 880 shares for tax withholding. The company may exchange the 880 shares with internal funds (the company money).
•First taxable event. Your cost basis, which is taxed at ordinary income tax rates, is based on the 4,000 shares multiplied by the employer’s stock price at vesting.
•Second taxable event. Now, you only have 3,120 shares in your brokerage account.
•Any gains or losses are based on the 3,120 shares.
•You do not have 4,000 shares because the 880 shares are for tax withholding.
•It’s like you earned $100,000 a year, and your employer withheld $22,000 for taxes. You only have $78,000 in your bank account.
•If your employer withholds too much tax, you will get a refund when you file your tax return. If the company did not withhold enough tax, you would have to pay for the tax when you file your tax return.
What happens when I make an 83(b) election, pay the taxes, and the restricted stock did not vest? Do I recapture the tax paid or forfeit the money?
•You forfeit the tax paid.
(Source: IRS - 83(b) election)
My restricted stock units and/or restricted stock vested, I sold shares of my employer’s stock at a loss, how am I taxed?
•Ordinary income tax rates on the fair market value at vesting.
•You have a capital loss on the difference between the stock price at the vesting date and the stock price at the sale date. The capital loss can offset capital gain if you have any. Any remaining loss can reduce up to $3,000 of your ordinary income. Any remaining loss will be carried into the future until all the loss is gone.
What happens to my restricted stock units and/or restricted stock when my company’s stock splits?
•Normally, companies like to split their stock because the stock price is high, and they want to split it, so it’s more affordable for investors.
•If the company announces a 2-for-1 stock split and you were supposed to get 50 shares, you will now get 100 shares because 50 X 2.
•If 3-for-1 stock split. 50 shares X 3 = 150 shares.
When should I sell my restricted stock units (RSUs) and/or restricted stock?
•It depends on your goals, financial position, your outlook on the company, et cetera.
•You should know there are two taxable events with restricted stock units and restricted stock. You get tax when the shares are vested and when you sell the employer’s stock.
•Restricted stock units and restricted stock are taxed as supplemental wages, which is the same as you getting paid for doing your job. Ask yourself, if you get paid for doing your job, will you take that money to buy the employer’s stock? Answering this question could help you determine if you should sell the shares when it vested or keep it and sell it later.
•The clients I have worked with have more than one type of equity compensation. In addition to restricted stock units and restricted stock, they may have employee stock purchase plans (ESPP), non-qualified stock options (NQSO), incentive stock options (ISOs). This makes the decision of when to sell the restricted stock units and restricted stock more complicated because of the timing of when to sell what is key. This is where you want to do tax bracket management. The goal of tax bracket management is to increase after-tax returns by reducing taxes in high-income years and increasing taxes in low-income years. There are so many strategies I want to talk about, but you will be sitting here for a couple of hours.
What are the disadvantages of restricted stock units and restricted stock?
•Vested restricted stock units and restricted stock increase your taxable income. Thus, you could be phased out of certain tax deductions and tax credits.
•The strategy is to control your tax bracket so you can maximize your wealth and there are so many strategies you can do, such as, should you making an 83(b) election for restricted stock to be tax at the grant date instead of the vesting date, branching itemized deductions in one year and taking the standard deduction in another year, and many more.
What are the common mistakes with restricted stock units and restricted stock?
•Employees don’t understand what they have and how to maximize their benefits. It’s like getting a new phone. You know how to use the phone, but you don’t know all the features that can improve your life.
•Employees don’t understand what the tax withholding rates are and why. The employers normally withhold 22% on the vested value on the vesting date, plus Medicare of 1.45% and Social Security of 6.2% if applicable. That is a total of 29.65%, and it does not include state and local taxes. Normally, there is a statutory withholding rate of 22% for supplemental income under a million and 37% withholding rate for supplemental income excess of a million. You have to know what is your total taxable income because if you make $400,000 at your company and $800,000 comes from your rental properties income and investments, the 22% withholding your company withhold is not enough to cover the taxes. Thus, you have to make the estimated tax to your state and federal government.
•The company did not withhold enough taxes when the restricted stock units and/or restricted stock vested, and you did not put aside money to pay for the difference when you do your tax return. Thus, you have to sell the employer’s stock when you don’t want to. For example, the company withholds 22% while you are in the 37% tax bracket. In this case, you want to set cash aside or log into your state website and the federal website to pay the estimated tax.
•Not withholding enough tax and employees keep doing it annually. There could be a penalty for underpayment.
•Employees thought they could make an 83(b) election on restricted stock units.
•Keep the employer’s stock after it vests and sell it in a year. The gain is short-term capital gain, and it’s taxed at ordinary income tax rates.
•Directly from the IRS website, ”Restricted Stock Units are unsecured, unfunded promises to pay cash or stock in the future and are considered nonqualified deferred compensation.” This means your employer promised you x numbers of restricted stock units that will vest in the future. That is just a promise, and there is nothing backing it up except for the employer's good faith.
•Employees change jobs before the restricted stock units and/or restricted stock vest; thus, the shares are not vested, and the employees will not get anything from the unvested shares.
•Employees are commingling the rules of restricted stock units, restricted stock, and other stock option plans. The big difference between restricted stock units, restricted stock, and stock options is you need pay to exercise the stock option, and restricted stock units and normally restricted stock are given to you, and you don’t exercise them.
•Not confirming all the numbers to make sure the tax reporting is correct. You must understand how you are being taxed on your restricted stock units and/or restricted stock. Make sure your supplemental income on form W-2 is properly reflecting the fair market value at vesting and the amount withheld by your employer.
•Having a concentrated stock position and not being aware of the risks.
•Not only are you taking on the unsystematic risks from the employer’s stock, if your company goes out of business or terminates you, you will lose your job and your wealth in the employer’s stock.
Problems with restricted stock units (RSUs) and restricted stock employees are confused about.
•How am I going to pay for the tax withholding?
•What to do with the employer’s stock once the stock is deposited in my account?
•What to do with the cash when I sell the employer’s stock?
How are restricted stock units (RSUs) and restricted stock taxed?
•You do not have a tax liability when restricted stock units and restricted stock are granted to you unless you make an 83(b) election on the restricted stock.
•You have a tax liability when the shares are vested based on the fair market value of the employer’s stock price times the number of shares. It’s taxed at ordinary income tax rates.
•You have another tax liability when you sell the employer’s stock if there is a gain.
•The change after the vesting date is considered capital gain or loss. Short-term or long-term depending on the holding period.
•If you sell the stock at a higher price than the value at vesting, you have a capital gain.
•If you sell the stock at a lower price than the value at vesting, you have a capital loss.
•If you sell the stock after a year (1 year + 1 day), that is considered long-term.
•If you sell the stock within a year, that is considered short-term.
•The most favorable tax treatment is long-term capital gains.
•If you have a capital loss. “Losses on your investments are first used to offset capital gains of the same type. So short-term losses are first deducted against short-term gains, and long-term losses are deducted against long-term gains. Net losses of either type can then be deducted against the other kind of gain. So, for example, if you have $2,000 of short-term loss and only $1,000 of short-term gain, the net $1,000 short-term loss can be deducted against your net long-term gain (assuming you have one). If you have an overall net capital loss for the year, you can deduct up to $3,000 of that loss against other kinds of income, including your salary and interest income, for example. Any excess net capital loss can be carried over to subsequent years to be deducted against capital gains and against up to $3,000 of other kinds of income. If you use married filing separate filing status, however, the annual net capital loss deduction limit is only $1,500.”
(Source: TurboTax - Capital Gains and Losses)
•You should get a 1099-B from your broker.
Taxation summary From MyStockOptions.
•“FICA taxes, including the 1.45% Medicare tax (plus the 0.9% additional Medicare tax for certain high-income taxpayers), is due at the vesting date. These arrangements allowing the deferral of the date when awards are taxed must comply with the deferred compensation rules of IRC Section 409A.”
(Source: MyStockOptions)
•The Federal Insurance Contributions Act (FICA) is a federal law that requires withholding of three separate taxes from the wages, 6.2% Social Security tax, 1.45% Medicare tax (the “regular” Medicare tax), and 0.9% Medicare surtax for high-income earners.
Taxation summary From Charles Schwab.
•With restricted stock units and restricted stock, “you are taxed when the shares are delivered, which is almost always at vesting. Your taxable income is the market value of the shares at vesting. You have compensation income subject to federal and employment tax (Social Security and Medicare) and any state and local tax. That income is subject to mandatory supplemental wage withholding. Withholding taxes, which for U.S. employees appear on Form W-2 along with the income, include the following: - federal income tax at the flat supplemental wage rate, unless your company uses your W-4 rate- Social Security (up to the yearly maximum) and Medicare- state and local taxes, when applicable.”
(Source: Schwab - RSUs Essential Facts)
Restricted stock summary.
•At grant = No tax, unless you make an 83(b) election for restricted stock
•At vesting = Taxable at ordinary income tax rates.
•At sell = Short-term or long-term and gain or loss depending on the holding period and sale price.
Strategies to consider with restricted stock units and restricted stock.
•Sell the shares once they are vested, then use the money to build a diversified investment portfolio, pay debts, fund a goal because restricted stock units and restricted stock are taxed as soon as they are vested.
•Keep the employer’s stock and use option contracts to mitigate the risks.
•Keep the employer’s stock and build a portfolio around the employer’s stock.
•Keep the employer’s stock, be in a concentrated stock position, then sell it when it’s advantageous to sell the employer’s stock.
•If you want to hold the employer’s stock, you should understand the risks of investing in individual stocks. I made a video on the risks of investing in individual stocks, and you can check it out at www.tanphan.com/blog.
•Exchange fund. If you currently have a lot of your employer’s stock and you don’t want to sell it because it will trigger a taxable event, you can look into doing an exchange fund where you exchange your employer’s stock for a diversified portfolio.
•The more money you have in stock options, such as restricted stock units, restricted stock, ESPP, ISOs, the more strategies are available to you because there are costs associated with the strategies.
Take advantage of the volatility in the stock price.
If you can sell certain shares at a loss, it’s advantageous to sell the shares and realize the loss.
Why?
•Lower your tax burden.
•Diversifying away from a concentrated stock position.
•Converting stocks into cash.
•Capital losses offset capital gains, then up to $3,000 from capital losses can offset ordinary income, then remaining losses can carry forward into the future.
•If you really like your employer’s stock, you can buy it back later, but be careful of the wash sale rule.
If you have restricted stock units and/or restricted stock that vested and/or going to vest, you should have a plan. You should also know how your employer’s stock or dollar value will work with your portfolio and overall financial plan. Without a plan, you could be paying a lot more in taxes and be exposed to the risks that are associated with a concentrated stock position.
Feel free to ask us questions so we can answer it in future videos. They are likely to be helpful to other employees as well.
This video is intended for educational purposes only and tax law changes. You should talk to a professional before making an informed decision.
Thank you for watching. This is Tan. Your trusted advisor.