What Is RSA Stock and How Is It Taxed?

Restricted Stock Awards (RSAs) are a form of equity compensation where employees receive company stock. Companies, particularly startups and privately held businesses, use RSAs to align employee incentives with long-term growth. RSAs serve as a powerful tool for attracting and retaining talent, especially when a company might not be able to offer high cash salaries.

Understanding Restricted Stock Awards

A Restricted Stock Award (RSA) involves the direct grant of company stock to an employee on a specified “grant date.” While the employee technically receives the shares upfront, these shares come with significant limitations. A primary characteristic is the “forfeiture risk,” meaning the shares can be taken back by the company if certain conditions, such as continued employment for a defined period, are not met.

Another limitation is the presence of “transfer restrictions.” Until these shares vest, they cannot be sold, transferred, or otherwise disposed of by the employee. Regarding shareholder privileges, employees typically gain voting rights on their unvested RSA shares immediately upon grant, and they may also receive dividends, although this can vary based on the specific grant agreement. These features distinguish RSAs from other equity compensation like Restricted Stock Units (RSUs), where actual shares are not issued until vesting.

The Vesting Process

Vesting is the process where restrictions on RSA shares are lifted, granting the employee full, unrestricted ownership. This process can be structured in various ways, primarily through time-based or performance-based schedules. Time-based vesting is common, often involving either “cliff vesting” or “graded vesting.”

Under cliff vesting, no shares vest for an initial period, but then a significant portion, or even all, of the shares vest at once on a specific date. For example, a common schedule might involve a one-year cliff followed by graded vesting. Graded vesting, conversely, allows portions of the shares to vest incrementally over time, such as a percentage vesting each year or quarter until fully vested. Performance-based vesting ties the release of shares to the achievement of specific company or individual performance metrics, like revenue targets or project milestones. Once shares vest, they are no longer subject to forfeiture, and the employee gains complete control over them.

Taxation of Restricted Stock Awards

The taxation of Restricted Stock Awards is primarily influenced by whether an employee makes a Section 83(b) election. Without an 83(b) election, the fair market value (FMV) of the RSA shares at the time they vest is considered ordinary income to the employee. This amount is subject to federal, state, and employment taxes, including Social Security and Medicare. The company is generally required to withhold these taxes from the employee’s wages or through a “sell-to-cover” arrangement. The cost basis for these shares, for future capital gains calculations, is established at the FMV recognized as ordinary income at vesting.

Alternatively, an employee can make a Section 83(b) election. This election allows the employee to recognize the FMV of the RSA shares at the grant date, rather than the vesting date, as ordinary income. The election must be made within a strict 30-day deadline from the grant date. Filing an 83(b) election can be advantageous if the company’s stock is expected to appreciate significantly between the grant date and the vesting date, as any future appreciation will then be taxed at potentially lower capital gains rates instead of ordinary income rates. It also starts the capital gains holding period earlier.

However, an 83(b) election carries risks. If the stock’s value declines or if the shares are forfeited due to not meeting vesting conditions, the tax paid on the grant date is generally not refundable. This means an employee could pay tax on stock they never fully own or that becomes worthless. When the shares are eventually sold, any difference between the sale price and the cost basis (established at either the grant date with an 83(b) election or the vesting date without one) will be treated as a capital gain or loss. The holding period for determining whether it’s a short-term or long-term capital gain begins on the date the income was recognized for tax purposes. Long-term capital gains, typically applicable if shares are held for more than one year from the tax recognition date, are generally taxed at more favorable rates than short-term gains.

After Vesting

Once RSA shares vest, the employee gains complete, unrestricted ownership. The employee has several options regarding these shares. One option is to hold onto the shares as an investment, becoming a direct shareholder in the company. This allows the employee to continue participating in any future appreciation of the company’s stock value.

Another option is to sell the vested shares. If the company is publicly traded, these shares can typically be sold on the open market through a designated brokerage account. For privately held companies, selling shares might be more restricted, often requiring participation in tender offers or company-sponsored buyback programs. Upon selling the shares, any difference between the sale price and the established cost basis (which was determined at the time the shares were taxed as ordinary income) will result in a capital gain or loss. This gain or loss will be subject to capital gains tax rates, which depend on how long the shares were held after the tax recognition event.