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A Restricted Stock Award (RSA) grants an employee shares of company stock, vesting at a future date. The stock is restricted from sale when granted. Once vested, the employee has full control over the stock.
At the time of granting, the employee has the option to accept or decline the offer. The employee should be aware of the tax implications associated with accepting the agreement, which will impact the company stock’s potential financial benefits.
Employees with Restricted Stock Awards default to having their award taxed as ordinary income when the stock vests (when the employee assumes control of the stock). The taxable value is calculated using the difference between the granted fair market value (less any amount paid for the stock at granting) and the fair market value of the stock at vesting.
Vested Value [$100K] = $100K Taxable Gains (Taxed at Ordinary Income Rates)
However, the tax equation does not end there. Now that the employee owns these shares with a vested cost basis ($100K), should the stock appreciate further and they decide to sell, they will pay capital gains tax on the difference between the vested basis and the value of shares at the time of sale. Alternatively, should the stock price decline below the vesting price, and the employee decides to sell, they will have a capital loss.
Sale Value [$110K] - Vested Value [$100K] = [$10K] Capital Gains (Taxed as Short or Long-Term)
A key consideration is that if the employee sells the stock immediately at vesting, they will likely minimize any potential gain or loss and associated tax bill. However, if the employee sells the stock within a year of vesting, they would be subject to short-term capital gains tax. If the employee sells the stock more than a year after vesting, they would be subject to long-term capital gains tax. Either way, the employee is required to determine the “optimal” time to sell.
There is an alternative option available to employees under Section 83(b) of the Internal Revenue Code.
The Section 83(b) election allows an employee to pay tax on the Restricted Stock Award at the time of granting – when property is transferred in connection with services. For example, if the employee was granted $10K of company stock, they would pay ordinary income tax on the fair market value of the award in the year it was granted.
This election must be filed in writing with the Internal Revenue Service (IRS) within 30 days of the grant.
The 83(b) election establishes the cost basis of the stock award at the time of granting rather than at vesting. Therefore, upon sale, whether at vesting or later, the employee would pay capital gains taxes. These capital gains can be short or long-term depending on whether the time between granting and vesting is less or more than one year.
Granted Value [$10K] = [$10K] Taxed as Ordinary Income
The advantage of the 83(b) election is avoiding a potentially large ordinary income tax burden in the year of vesting by paying the ordinary income tax at the time of granting as well as beginning the long-term capital gains tax clock before vesting. The downside of the 83(b) election is that if employee does not vest, they are left having paid taxes upfront that cannot be reclaimed.
Sale Value [$110K] - Granted Value [$10K] = $100K Capital Gains (Taxed as Short or Long-Term)
In the example above, the stock could have been sold at the vesting date, in which case the calculation would be:
Sale Value [$100K] - Granted Value [$10K] = $90K Capital Gains (Taxed as Short or Long-Term)
The examples above (No election and 83(b) election) reveal that by the time of vesting the employee would have either paid $100K in ordinary income tax, or $10K in ordinary income tax. And at the time of sale, $100K in ordinary income tax plus $10K in capital gains, or $10K in ordinary income plus $100K in capital gains.
Completing this calculation (estimation) at the time of granting is complicated by numerous variables including the stock price movement, the employee tax bracket in each of these tax years, changes to ordinary and capital gains taxation rates, probability that employee remains with company to vest, etc. As a result, it is critical to speak with your tax accountant before deciding to make a Section 83(b) election.
Restricted Stock Awards can be a wonderful benefit from an employer, but they require foresight at the time of granting, vesting, and sale to plan for the tax implications. Whether or not the tax bill is big, you can choose to be prepared or not.
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