When and How Is Restricted Stock Taxed?

Restricted stock serves as a common form of equity compensation, frequently offered to employees. It allows individuals to gain company ownership, aligning their interests with the organization’s success. Understanding when and how this compensation is taxed is important for recipients, as tax timing impacts financial planning and obligations. This article clarifies when restricted stock becomes taxable, providing essential information for effective management.

Understanding Restricted Stock Vesting

Restricted stock refers to company stock not fully owned by the employee until certain conditions are met. A vesting schedule dictates when restrictions lapse and shares become transferable. Two primary types of restricted stock exist: Restricted Stock Units (RSUs) and Restricted Stock Awards (RSAs).

Restricted Stock Units (RSUs) are a promise from an employer to deliver company stock or its cash equivalent in the future, once conditions are met. Employees do not own the shares at grant; they receive them upon vesting. Restricted Stock Awards (RSAs) involve the actual grant of company stock at award, subject to forfeiture until vesting. With RSAs, employees may sometimes have voting rights and receive dividends on the shares even before vesting, which is generally not the case with RSUs.

Vesting schedules impose conditions that must be fulfilled before restricted stock is fully earned. Common types include time-based vesting (shares vest after a period of employment) and performance-based vesting (requires achieving goals). For instance, a time-based schedule might release 25% of the shares each year over a four-year period. Some schedules incorporate “cliff” vesting, where no shares vest until an initial period (e.g., one year) has passed, after which a substantial portion or all shares vest. Until these conditions are met, shares are subject to “substantial risk of forfeiture,” meaning the employee could lose them if they depart the company or fail to meet targets.

Taxation at Vesting

For most restricted stock, taxation occurs when shares vest, meaning restrictions lapse and the employee gains full ownership. At this point, the fair market value (FMV) of vested shares is treated as ordinary income. This is similar to how a cash bonus or wages are taxed, subject to federal, state, and payroll taxes (Social Security and Medicare).

The taxable amount is calculated by multiplying the number of vested shares by their FMV on the vesting date. For example, if 100 shares vest when the stock’s FMV is $50 per share, the employee recognizes $5,000 in ordinary income. This income and taxes are reported on the employee’s Form W-2. Employers handle the withholding.

Common withholding methods include “sell-to-cover,” where a portion of vested shares are sold to cover the tax obligation. Another method is “net share settlement,” where the company retains shares equal to the tax withholding, and remaining shares are deposited into the employee’s brokerage account. Employees can also pay taxes with cash, keeping all vested shares. The fair market value at vesting also establishes the cost basis for the shares for future capital gains calculations.

Making an 83(b) Election

An 83(b) election offers alternative taxation timing for certain restricted stock awards. It allows recipients to include the restricted property’s fair market value in their gross income in the year of transfer (grant date) instead of at vesting. This can be advantageous if the stock’s value is low at grant and expected to appreciate significantly by vesting. With this election, future appreciation between grant and vesting is taxed at potentially lower capital gains rates upon sale, not as ordinary income.

The 83(b) election applies to Restricted Stock Awards (RSAs), not Restricted Stock Units (RSUs), as RSUs do not involve actual share transfer until vesting. A strict 30-day deadline applies to the 83(b) election. It must be filed with the IRS no later than 30 days after the restricted property is transferred (grant date). This deadline is absolute; no extensions are provided, and missing it forfeits the election opportunity. If the 30th day falls on a weekend or legal holiday, the deadline extends to the next business day.

To make an 83(b) election, a written statement must be filed with the IRS. The IRS introduced Form 15620 for this, though a written statement meeting Treasury Regulations is also acceptable. The statement must include: taxpayer’s name, address, Social Security number; property description (e.g., number and type of shares); transfer date; nature of restrictions; and amount paid for the property. This statement should declare an election is being made under Internal Revenue Code Section 83(b).

The completed and signed election should be mailed to the IRS service center where the taxpayer files their federal income tax return. Sending the election via certified mail with a return receipt is recommended for proof of timely filing, as the burden of proof rests with the taxpayer. A copy must also be provided to the employer, and the taxpayer should retain a copy. The IRS also now permits electronic filing of Form 15620 through its website, which can streamline the process.

Taxation Upon Sale of Vested Stock

Once restricted stock has vested (or an 83(b) election was made at grant), any subsequent sale is subject to capital gains or losses. This differs from ordinary income taxation at vesting because shares are now investment property. The capital gain or loss is determined by the difference between the sale price of the shares and their cost basis.

The cost basis for vested restricted stock is the fair market value of the shares on the vesting date, which was the amount previously included as ordinary income. If an 83(b) election was made, the cost basis is the fair market value on the grant date. For example, if shares vested at $50 and are later sold at $70, the $20 difference per share is the capital gain. If sold at $40, the $10 difference per share would be a capital loss.

The taxation of capital gains or losses depends on the holding period of the shares. If shares were held for one year or less from the vesting date (or grant date if an 83(b) election was made), any gain is a short-term capital gain, taxed at ordinary income rates. If held for more than one year from the vesting date (or grant date with an 83(b) election), any gain is a long-term capital gain, qualifying for lower tax rates.

Sales of vested stock are reported on various tax forms. Form 1099-B, “Proceeds From Broker and Barter Exchange Transactions,” is issued by the brokerage firm handling the sale, detailing gross proceeds and sometimes cost basis. This information is used to complete Form 8949, “Sales and Other Dispositions of Capital Assets,” and Schedule D, “Capital Gains and Losses,” when filing federal income tax returns.