What Is Restricted Stock?.
Tax advantages on employee share schemes including Share Incentive Plans, Save As You Earn, Company Share Option Plans and Enterprise Management Incentives. Remember that selling your employee stock immediately after exercise will induce the higher short-term capital gains tax. Waiting until the sale qualifies for the lesser long-term capital gains.
An employee stock option is granted at a specific price, known as the exercise price. It is the price per share that an employee must pay to exercise his or her options. The exercise price is important because it is used to determine the gain, also called the bargain element, and the tax payable on the contract.
The bargain element is calculated by subtracting the exercise price from the market price of the company stock on the date the option is exercised. The Internal Revenue Code also has a set of rules that an owner must obey to avoid paying hefty taxes on his or her contracts. The taxation of stock option contracts depends on the type of option owned.
Although the timing of a stock option strategy is important, there are other considerations to be made. Another key aspect of stock option planning is the effect that these instruments will have on overall asset allocation. For any investment plan to be successful, the assets have to be properly diversified. An employee should be wary of concentrated positions on any company's stock. While you may feel comfortable investing a larger percentage of your portfolio in your own company, it's simply safer to diversify.
Conceptually, options are an attractive payment method. In practice, however, redemption and taxation of these instruments can be quite complicated. Most employees do not understand the tax effects of owning and exercising their options. As a result, they can be heavily penalized by Uncle Sam and often miss out on some of the money generated by these contracts. Remember that selling your employee stock immediately after exercise will induce the higher short-term capital gains tax.
Waiting until the sale qualifies for the lesser long-term capital gains tax can save you hundreds, or even thousands. What's an Employee Stock Option? Grant Date, Expiration, Vesting and Exercise To begin, employees are typically not granted full ownership of the options on the initiation date of the contract, also know as the grant date.
Taxing Employee Stock Options The Internal Revenue Code also has a set of rules that an owner must obey to avoid paying hefty taxes on his or her contracts.
For non-qualified stock options NSO: The grant is not a taxable event. Taxation begins at the time of exercise. The bargain element of a non-qualified stock option is considered "compensation" and is taxed at ordinary income tax rates.
The sale of the security triggers another taxable event. If the employee decides to sell the shares immediately or less than a year from exercise , the transaction will be reported as a short-term capital gain or loss and will be subject to tax at ordinary income tax rates. If the employee decides to sell the shares a year after the exercise, the sale will be reported as a long-term capital gain or loss and the tax will be reduced.
Incentive stock options ISO receive special tax treatment: This article will examine the nature of restricted stock and restricted stock units RSUs and how they are taxed.
Restricted stock is, by definition, stock that has been granted to an executive that is nontransferable and subject to forfeiture under certain conditions, such as termination of employment or failure to meet either corporate or personal performance benchmarks. Restricted stock also generally becomes available to the recipient under a graded vesting schedule that lasts for several years.
Although there are some exceptions, most restricted stock is granted to executives who are considered to have "insider" knowledge of a corporation, thus making it subject to the insider trading regulations under SEC Rule Failure to adhere to these regulations can also result in forfeiture.
Restricted stockholders have voting rights , the same as any other type of shareholder. Restricted stock grants have become more popular since the mids, when companies were required to expense stock option grants.
RSUs resemble restricted stock options conceptually, but differ in some key respects. RSUs represent an unsecured promise by the employer to grant a set number of shares of stock to the employee upon the completion of the vesting schedule.
Some types of plans allow for a cash payment to be made in lieu of the stock, but most plans mandate that actual shares of the stock are to be issued — though not until the underlying covenants are met. Therefore, the shares of stock cannot be delivered until vesting and forfeiture requirements have been satisfied and release is granted. Some RSU plans allow the employee to decide within certain limits exactly when he or she would like to receive the shares, which can assist in tax planning.
However, unlike standard restricted stockholders, RSU participants have no voting rights on the stock during the vesting period, because no stock has actually been issued. To delve deeper, see " Restricted Stock Units: What to Know ". Restricted stock and RSUs are taxed differently than other kinds of stock options , such as statutory or non-statutory employee stock purchase plans ESPPs. Those plans generally have tax consequences at the date of exercise or sale, whereas restricted stock usually becomes taxable upon the completion of the vesting schedule.
For restricted stock plans, the entire amount of the vested stock must be counted as ordinary income in the year of vesting. The amount that must be declared is determined by subtracting the original purchase or exercise price of the stock which may be zero from the fair market value of the stock as of the date that the stock becomes fully vested. The difference must be reported by the shareholder as ordinary income. However, if the shareholder does not sell the stock at vesting and sells it at a later time, any difference between the sale price and the fair market value on the date of vesting is reported as a capital gain or loss.
Shareholders of restricted stock are allowed to report the fair market value of their shares as ordinary income on the date that they are granted, instead of when they become vested, if they so desire. The capital gains treatment still applies, but it begins at the time of grant. This election can greatly reduce the amount of taxes that are paid upon the plan, because the stock price at the time the shares are granted is often much lower than at the time of vesting.
The Bottom Line There are many different kinds of restricted stock, and the tax and forfeiture rules associated with them can be very complex. Some types of plans allow for a cash payment to be made in lieu of the stock, but most plans mandate that actual shares of the stock are to be issued — though not until the underlying covenants are met.
Cost of establishment and administration of the Sub-Plan is deductible for corporation tax purposes. There are many different kinds of restricted stock, and the tax and forfeiture rules associated with them can be very complex.