Many companies offer stock as part of an employee compensation plan. This stock becomes vested when the employee actually owns the stock, meaning that he won't lose the stock if his employment is terminated. Note that vesting doesn't necessarily mean the employee is free to use the stock in any way he likes.
Employee Stock Compensation
When a company offers an employee stock as part of her compensation, that stock is generally restricted. As the name suggests, restricted stock has certain restrictions on how the owner may use it. Generally, the employee must hold on to the restricted stock for a certain period defined by the issuing company. During this period, the employee can't sell or otherwise dispose of the stock. Some companies also offer stock options as part of the employee compensation plan; these options also typically carry some restrictions on when they can be exercised by the employee.
Even if an employee earns stock as compensation, he doesn't actually have the right to do anything with the stock until it is vested. Vesting means that the employee's rights in the stock are no longer potential, something promised by the company. Vested rights are absolute, and the employee has the right to bring suit if those vested rights are withheld or damaged. Employee stock rights become vested either when the employee has the right to transfer the stock without any restrictions or limitations, or when the employee can leave his employment without losing any of his rights to the stock.
The Vesting Period
When a company offers stock to an employee as compensation, the stock generally comes with a "vesting period." During this period, the employee is prohibited from selling the stock. Until the vesting period is done, the stock doesn't vest. If the employee leaves the company during the vesting period, he generally loses some or all of his rights in the stock. However, once the stock has vested, the employee has the right to do whatever he wants with it, unless the terms of the stock itself place permanent limitations on the owner.
The vesting of stock can have serious federal income tax consequences. The IRS treats payment of compensation in stock just like a payment in cash, meaning that the employee must pay income tax on the fair market value of the stock. However, the IRS will not tax such stock compensation until it has vested. In the IRS rules, vesting means that there is no longer a real risk of the employee being forced to forfeit, or return the stock to the company. Generally, when the stock becomes vested, the employee will need to pay income tax on it, even if he hasn't sold or transferred the stock.
Erika Johansen is a lifelong writer with a Master of Fine Arts from the Iowa Writers' Workshop and editorial experience in scholastic publication. She has written articles for various websites.