Restricted stock awards are similar to stock options; employers use both to compensate employees by offering them shares of stock in the company. Restricted stock will go through different periods of “vesting” and will trigger different tax treatment along the way, including both ordinary income tax and capital gains taxes. Investors can collect dividends on restricted stocks. The dividends are also subject to different tax treatment that depends upon the length of time the stock has been owned.
Restricted Stock Awards
Restricted stock awards don’t offer the same upside benefit as stock options, writes "USA Today," but they are a safer option if the company stock price doesn't soar. Employees don’t get full ownership rights of restricted stocks until they become vested, usually by working at the company for five years or more, whereas stock options gives employees an option to buy stock at a set price in the future. Stock options can pay off if the stock price rises, but if it's steady or drops, they lose their value. Restricted stocks are free to the employees, so long as they stay at the company for the vesting period. Even if the share price drops, the value of the stock can be collected free of charge by an employee. As a result, employers usually give fewer shares of restricted stock than they allow for stock options.
Vesting Restricted Stocks
Employees have few options to control their tax bill when they receive restricted stocks awards. With stock options, employees can exercise the options when they are ready, which lets them decide when to take the tax bill. With restricted stock awards, employees owe income taxes on them immediately upon reaching the vesting period. Restricted stock awards are treated like income on which ordinary taxes are owed, depending upon the investor’s tax bracket. Taxes are owed on the value of the stock when they vest, not when the stocks are granted to the employee.
Restricted Stock Dividends
Employees can collect dividends on restricted stock awards, even if the stock hasn't vested, according to "USA Today." Employees collecting dividends on stocks that aren't vested owe the Internal Revenue Service ordinary income taxes on the payments. Once the stocks become vested, employees will then only owe capital gains taxes, which are usually lower than income taxes. If an employee holds the stock after it has vested for more than one year, then income from the sale of the stock will also qualify for capital gains taxes.
Special Tax Treatment
Owners of restricted stock awards can choose to be taxed under Section 83(b), which lets them pay taxes within 30 days of receiving the award grant. By paying the taxes at the front end, employees can reap a benefit if the shares rise, as they won’t have to pay higher taxes later. If an employee leaves the job before the required period for vesting, he won’t be vested in the stock and will have paid taxes on benefits that he never received. Paying taxes under 83(b) also lets employees claim capital gains tax treatment for any future dividends received from the restricted stocks.
Terry Lane has been a journalist and writer since 1997. He has both covered, and worked for, members of Congress and has helped legislators and executives publish op-eds in the “Wall Street Journal,” “National Journal” and “Politico." He earned a Bachelor of Science in journalism from the University of Florida.