Thanks, Boss, for the Restricted Stock and RSU’s! What Are They and What Do I Do Now?

By Charles J. Lewandowski CFP® MBA

Sue and Jim recently came to my office to discuss their new compensation packages. Sue, a VP at a startup Technology company had received a Restricted Stock award and Jim received a Restricted Stock Unit (RSU) grant from his employer, a large Health Care conglomerate. Neither of them understood what they received and the impact that these awards had on their financial plans. Both were concerned about the tax impact that the increased compensation had on their take home earnings. What were the similarities and differences between the two packages and how could they minimize taxes due because of the awards?

 Some History

During the tech boom of the 1990’s, stock option grants were the preferred method of employee incentive compensation due to the possibility of acquiring great wealth if the company stock price increased significantly and the options were exercised “in the money”.  However, if the stock price did not exceed the exercise or “strike price” of the option, the options were worthless. Restricted Stock awards and Restricted Stock Units became popular in the mid 2000’s once corporations were required to recognize stock option grants as an expense. Unlike stock options which may not have any value if the strike price is not attained, Restricted stock and RSU’s have value unless the company’s stock price goes to zero.

Restricted Stock – A Primer

Restricted stock comes, as the name implies, with restrictions. Many employers would like to use company stock as an incentive for their employees to reach certain milestones. These milestones may be as simple as remaining with the firm for a certain number of years. In Sue’s case, she would receive shares if she remained with the company for three years. Or the trigger may be performance related such as achieving certain levels of sales or profitability. If the employee does not meet these objectives, then the stock is not awarded.  

Restricted stock is granted to the employee on a specific date, the grant date. The grant identifies the number of shares awarded and a vesting schedule. The shares are held by the company until vested. Once the shares are vested, the employee receives the full value of the shares as compensation.

Tax Implications of Restricted Stock

To receive her shares, Sue was required to stay at the Technology company for three years. If she left the company, she would not receive the shares. Sue had a “risk of forfeiture’ so she would not be taxed for the shares until they vested. Once vested, however, the value of the shares is considered to be compensation and her tax obligation would include ordinary income, state, and payroll taxes. At her direction, her company could sell a portion of the shares to pay the tax obligation. She could hold the remaining shares for over one year and receive favorable capital gains treatment once she sold those shares.

Sue does have the opportunity to modify the timing of her tax obligation, however. Section 83(b) of the Internal Revenue Code allows the employee to choose whether to pay taxes at the time of the grant or at the time of vesting. Since Sue is working for an early stage Technology company, she could choose to pay taxes at the time of the grant if she believes there is a good chance that the stock price will increase significantly in the future. The downside of this choice is the stock price could go lower in the future and she would have paid taxes on the higher price at the time of the grant. (Consult with your tax advisor before making this election.)

Restricted Stock Units (RSU’s) – A Primer

Restricted Stock Units (RSU) are very similar to Restricted Stock but there are some critical differences. RSU’s are not shares of stock but they represent a commitment by the employer to give you stock based on a pre-determined schedule. RSU’s do not receive dividends directly and they are not eligible for the 83(b) election because no shares are issued until they are vested. If your company has a deferred compensation plan, RSU’s may be deferred into that plan while Restricted Stock cannot be deferred. (Consult with your tax advisor.)

Tax Implications of RSU’s

The value of Restricted Stock Units is taxed in a similar manner as Restricted Stock. Once the units vest, federal income taxes, state taxes, payroll taxes are assessed. The 83(b) election is not available at the issuance of the award. However, the vesting of the RSU’s may be delayed to a period in the future.

Jim, the Health Care Executive, had decided to retire in a couple of years. He was able to defer the vesting of the shares until after his retirement when he would be in a much lower tax bracket by placing them in his company’s deferred compensation plan.

Impacts on Your Financial Plan

The vesting of Restricted Stock and Restricted Stock Units can significantly increase employment income during the years that they vest. Several opportunities exit to reduce the tax impact of the awards. These include

·        Manage the timing of the sale of vested shares to maximize Long Term Capital Gains rates

·        83(b) election

·        Deferral of RSU vesting using the company’s deferred compensation plan

·        Maximizing 401(k) deferral

·        Maximizing HSA contributions

None of these options should be taken in a vacuum.  Once you hear the words “Congratulations, you will be receiving Restricted Stock” a comprehensive financial plan should be developed by a CERTIFIED FINANCIAL PLANNER™ professional with significant input from your CPA.

Call me so we can start now.

09/2020

Advisory services offered through Capital Analysts or Lincoln Investment, Registered Investment Advisers. Securities offered through Lincoln Investment, Broker Dealer, Member FINRA/SIPC. www.lincolninvestment.com 

West Coast Financial Group, Inc. and the above firms are independent and non-affiliated.

Tax advice is not offered through, nor supervised by Lincoln Investment or Capital Analysts.

Contributions to a Roth IRA are not tax-deductible and there is no mandatory distribution age. All earnings and principal are tax-free if rules and regulations are followed. Eligibility for a Roth account depends on income. Principal contributions can be withdrawn at any time without penalty (subject to some minimal conditions).