What Is a Stock Grant and How Does It Work?

A stock grant is a form of non-cash compensation where a company provides its employees with shares of its stock. Companies use stock grants to attract and retain talent, offering immediate ownership without an upfront purchase. It aligns employee interests with company performance and shareholder value. They are a common equity compensation component, incentivizing long-term commitment.

How Stock Grants Work

A company initiates a stock grant by awarding a specified number of its shares to an employee. These shares are not immediately available for the employee to control or sell; instead, they are subject to specific conditions that must be met before full ownership is transferred. The main condition is a vesting schedule, dictating when the employee gains unrestricted rights.

Vesting is the process by which an employee earns full ownership of granted shares over time or upon meeting criteria. A common approach is time-based vesting, where a portion of the shares becomes available at regular intervals. For instance, a “cliff” vesting schedule might stipulate that no shares vest until an employee completes a full year of service, after which a significant portion, or even all, of the shares vest at once.

Following the initial cliff, remaining shares vest incrementally over subsequent years, a process known as graded vesting. For example, a grant might vest 25% after the first year and then 6.25% quarterly over the next three years, totaling a four-year vesting period. This phased approach encourages employee retention, as departing before a vesting date means forfeiture of unvested shares.

Beyond time-based conditions, some stock grants may include performance-based vesting criteria. These conditions tie the release of shares to the achievement of specific company milestones, such as revenue targets or product launches, or individual performance goals. The shares vest only if these predefined metrics are met.

Upon a vesting event, the employee gains full ownership of the specified number of shares. These vested shares are then delivered to the employee, transferred into a brokerage account. The employee can then hold the shares, potentially benefiting from future appreciation, or sell them for cash.

Stock grants differ from other equity compensation because employees do not pay to acquire the shares. Unlike stock options, which require purchasing shares at a predetermined price, stock grants are directly given as compensation once vesting requirements are satisfied. This eliminates any upfront cash outlay for the employee.

Taxation of Stock Grants

The taxation of stock grants occurs at specific junctures: primarily at vesting and subsequently at sale. When a stock grant vests, the fair market value of the shares on the vesting date is considered ordinary income to the employee. This amount is subject to various withholdings, including federal, state, and local income taxes, and payroll taxes like Social Security and Medicare.

The company withholds a portion of the vested shares or cash from other compensation to cover these tax obligations. The fair market value of the shares at vesting establishes the employee’s cost basis for those shares. For tax purposes, the employee is treated as having “purchased” the shares at that value, as that amount has already been recognized and taxed as ordinary income.

When vested shares are sold, any difference between the sale price and cost basis is a capital gain or loss. If the shares are sold within one year of the vesting date, any profit is classified as a short-term capital gain, taxed at the employee’s ordinary income tax rate. Conversely, a loss would be a short-term capital loss.

If the shares are held for more than one year after vesting before being sold, any profit is considered a long-term capital gain. Long-term capital gains may benefit from preferential tax rates, which are lower than ordinary income tax rates, depending on the taxpayer’s income bracket. A loss incurred after holding for more than one year would be a long-term capital loss. Tax laws vary, so individuals receiving stock grants should consult a qualified tax professional for personalized advice.

Stock Grants Versus Other Equity Compensation

Stock grants are one of several forms of equity compensation, each with distinct characteristics. Understanding these differences clarifies the unique nature of stock grants. Distinctions often lie in how ownership is conferred and financial mechanics.

A stock grant is similar to a Restricted Stock Unit (RSU), and the terms are often used interchangeably, though a difference exists. A stock grant involves the immediate grant of actual shares, restricted by a vesting schedule. Conversely, an RSU represents a promise to deliver shares or their cash equivalent in the future, once vesting conditions are satisfied. The tax treatment for both RSUs and stock grants is the same at the point of vesting, where the fair market value is taxed as ordinary income.

In contrast, stock options provide an employee with the right, but not the obligation, to purchase a company’s shares at a pre-determined price, known as the exercise or strike price, within a specific timeframe. The employee must pay money to “exercise” the option and acquire the shares. With stock grants, shares are given to the employee without a purchase requirement. The tax implications for stock options are triggered upon exercise, which differs from the vesting trigger for stock grants.

Employee Stock Purchase Plans (ESPPs) offer another avenue for employees to acquire company stock, but they operate differently from stock grants. ESPPs allow employees to purchase company shares through payroll deductions. This is a purchase program, not a direct grant of shares. The employee actively chooses to buy shares, whereas with a stock grant, shares are awarded as compensation.