How Are Restricted Stock Options Taxed?
Understand the key tax events for your employee stock. Learn how your equity compensation becomes income and how to properly report the sale to manage your tax liability.
The term “restricted stock options” often causes confusion because it can blend different types of equity awards. The two most common forms are Restricted Stock Awards (RSAs) and Restricted Stock Units (RSUs), which are direct grants of company stock subject to restrictions before you gain full ownership. Unlike traditional stock options that provide the right to purchase stock, RSAs and RSUs involve the direct grant of the stock itself.
Understanding Restricted Stock and Vesting
Restricted stock is a grant of company shares to an employee that is not fully owned until specific conditions are met. These shares are “restricted” because you cannot sell or transfer them freely, with the restrictions outlined in a formal grant agreement. The purpose of these restrictions is to serve as an incentive for an employee to remain with the company.
The process of earning full ownership of these shares is called vesting. Vesting means the restrictions are lifted, and the stock becomes yours without limitation. The conditions for vesting are typically based on a time-based schedule, performance goals, or a combination of both.
A common vesting schedule is graded vesting over four years with a one-year “cliff.” In this structure, you receive no vested shares for the first year of service. On your first anniversary, 25% of your total granted shares vest, and the remainder often vests monthly or quarterly over the next three years.
A Restricted Stock Award (RSA) is a grant of actual shares on the grant date, which are held in escrow by the company until they vest. A Restricted Stock Unit (RSU) is a promise from your employer to deliver a specified number of shares at a future date, once vesting conditions are met.
Tax Treatment of Restricted Stock
The tax implications of restricted stock are determined by when you are considered to have received the income. For both RSUs and RSAs where no special tax election is made, the taxable event is the vesting date. This is when the IRS considers you to have full control over the shares, and therefore, you have received taxable income.
Taxation of RSUs
For Restricted Stock Units, no tax event occurs on the grant date because you have only received a promise of future shares. The taxable event occurs when the shares vest and are delivered to you. On the vesting date, the fair market value of the shares is considered ordinary income, subject to federal, state, and payroll taxes.
Your employer will report this income on your Form W-2. For example, if 1,000 RSUs vest when the stock’s fair market value is $25 per share, you will recognize $25,000 as ordinary income. Your employer is required to withhold taxes on this amount, often by selling a portion of the newly vested shares.
This value establishes your cost basis in the shares you retain, which is $25 per share in this example. Any subsequent change in value from the vesting date to the sale date is treated as a capital gain or loss.
Taxation of RSAs
When you receive a Restricted Stock Award and do not make a Section 83(b) election, the tax treatment is identical to that of an RSU. Although you receive the shares on the grant date, they are subject to a substantial risk of forfeiture. Because of this risk, the IRS does not consider the income to be yours until the vesting date.
The fair market value of the shares on the vesting date, minus any amount you paid for them, is taxed as ordinary income and reported on your W-2. For instance, if 500 RSA shares you received for no cost are worth $50 each on the vesting date, you will have $25,000 of ordinary income.
This value establishes your cost basis for the shares going forward for any future sale.
The Section 83(b) Election
Recipients of Restricted Stock Awards (RSAs) have access to a tax planning tool not available for RSUs: the Section 83(b) election. This provision allows you to change the timing of your tax liability. By making this election, you choose to pay ordinary income tax on the value of your RSA shares at the grant date, rather than waiting until the vesting date.
The motivation for an 83(b) election is potential tax savings, particularly with early-stage companies where the stock value at grant is very low. By paying tax on this low value upfront, any subsequent appreciation in the stock’s value is treated as a capital gain, which is generally taxed at lower rates than ordinary income.
However, this strategy involves risk. If you make the election and pay taxes but then leave the company before the shares vest, you forfeit the shares. The IRS does not allow you to recover the taxes you paid on the forfeited stock.
To make a Section 83(b) election, you must file a written statement with the IRS no later than 30 days after the date the stock was granted. This 30-day deadline is absolute. The election letter must include:
- Your name, address, and taxpayer identification number
- A description of the property (the shares)
- The date of the grant and the taxable year
- The fair market value of the shares at grant and any amount you paid for them
You must mail this letter to the IRS service center where you file your taxes and provide a copy to your employer. It is recommended to send it via certified mail for proof of timely filing.
Reporting on Your Tax Return
Properly reporting income from restricted stock on your tax return is a multi-step process. The ordinary income you recognized when your RSUs or RSAs vested is included in the wages reported in Box 1 of your Form W-2. Some employers may also provide a breakdown of this income in Box 14 for informational purposes.
When you sell your shares, your brokerage firm will issue a Form 1099-B. A common issue arises here: the cost basis reported in Box 1e of the 1099-B is often incorrect. Brokers frequently report the basis as zero because they are not required to include the compensation element you already recognized on your W-2.
If you use the incorrect basis from Form 1099-B, you will end up paying tax twice on the same income—once as ordinary income at vesting and again as a capital gain at sale.
To prevent this, you must manually adjust the cost basis on Form 8949, “Sales and Other Dispositions of Capital Assets.” Your correct cost basis is the amount of ordinary income you recognized at vesting, which is the fair market value of the shares on that date. The totals from Form 8949 are then carried over to Schedule D, “Capital Gains and Losses.”
Impact of Employment Changes
The status of your employment has a direct impact on your restricted stock. The rules governing what happens upon termination or resignation are detailed in your company’s equity plan and your specific grant agreement. It is important to review these documents to understand the consequences.
In most cases, if you leave your company for any reason before your shares have vested, you will forfeit all unvested shares. Whether you resign voluntarily or are terminated, the unvested portion of your grant is returned to the company.
Conversely, any shares that have already vested by your departure date are your property. You retain full ownership of these shares after your employment ends and are free to hold or sell them, subject to any company-specific trading windows or policies.
Some grant agreements include provisions for special circumstances that can alter the standard vesting rules. For example, events like a layoff, death, or disability may trigger accelerated vesting. A change in control, such as the acquisition of your company, can also lead to accelerated vesting for outstanding grants.