Restricted stock is one of the more popular forms of employee stock compensation. These two forms of restricted stock you’ll see are restricted stock units and restricted stock awards. Both are used in addition to cash compensation to reward and hang on to employees through a vesting schedule.
While the names of these types of restricted stock are similar, there are important distinctions to know. If you want the TLDR version, here is an infographic comparison for you.
If you’re ready to understand the key differences between restricted stock units and restricted stock awards, let’s get started.
When RSUs are granted, you don’t own them. They are future promises made by your employer and then issued after a vesting period. This means a period of time must pass before you own the shares and they are in your name. Once the vesting period is met, the stock is issued to you, and you are free to do what you would like with the shares.
Unlike RSUs, Restricted Stock Awards are issued on the grant date. In other words, these shares are given to employees on the grant date. Sometimes, an employer may allow RSAs to be purchased at a discount or fair market value at the time of grant. Even though you own the shares, they are held in an escrow account until a vesting period is met. If this vesting period is not met, the shares are paid back to your employer.
The taxes on RSUs is fairly straightforward. On the vesting date, RSUs are taxed as ordinary income based on the share value. This value is considered compensation income on your W2 and is subject to federal, state/local, social security, and Medicare taxes.
They are essentially a cash bonus paid to you in the form of company stock.
Even though you’re issued RSAs on the grant date, there are no taxes until vesting. Unless you make an 83(b) election.
If you make an 83(b) election within 30 days of the stock grant, the RSAs are taxed as compensation income when they are granted. Then no taxes are due until they are sold.
If you don’t make an 83(b) election, you’ll pay compensation income on the value of the shares at vesting, similar to RSUs.
If you sell RSUs as soon as they vest, there won’t be any capital gains or losses. However, if you continue to hold the shares after the vesting date, you’ll incur capital gains (or losses) based on the holding period after vesting. Shares sold more than one year and a day after vesting will be subject to long-term capital gains (or losses). Shares sold within one year after vesting will be subject to short-term gains (or losses).
The stock basis for determining capital gains or losses is the stock’s fair market value at vesting.
RSAs are subject to long-term capital gains (or losses) if you hold the stock for more than a year. Conversely, if the stock is sold before the one-year mark, it’s a short-term capital gain (or loss).
The basis for the stock to determine capital gains and losses is the amount paid for the stock (if you paid for the RSA), plus the amount of income reported at vesting.
If you don’t make an 83(b) election, the capital gain or loss holding period starts on the vesting date.
If an 83(b) election is made, the holding period for capital gains begins on the grant date. This starts the clock ticking sooner for capital gains.
You cannot make an 83(b) election on restricted stock units.
As mentioned above, you may elect 83(b) on RSAs. However, you must make this election within 30 days from the grant date. This can change the tax dynamic and holding period for compensation income and capital gains. When 83(b) is elected, taxes are paid upfront based on the stock price on the grant date. The downside to 83(b) is that you might pay tax on shares you never receive if you leave the company or forfeit shares before vesting.
Since shares are not issued until vesting, RSUs don’t pay dividends. However, an employer may provide employees with dividend equivalent payments on unvested RSUs. These equivalents are typically held in an escrow account to pay for tax withholding or purchase additional shares.
You may receive dividends on RSAs while in the vesting period. Dividends received are considered compensation income and taxed at ordinary income rates.
RSUs are simply a future promise until they vest and do not have voting rights. However, once the shares vest, they will have voting rights.
RSAs have voting rights at the time they are issued on the grant date.
Now that you understand the difference between restricted stock units and restricted stock awards, you’ll be better prepared to create a strategy for your equity compensation. It’s important to understand the mechanics of your equity compensation to increase the value of your dollars on your way to financial freedom.