Making the Most of Restricted Stock Awards
Your client received a Restricted Stock Award (RSA). So naturally, they have questions that may range from the basics to maximizing the after-tax value. This article reveals how RSAs work, their pros and cons, and tax issues.
How RSAs Work
Restricted Stock Awards (RSAs) are a form of equity-based nonqualified deferred compensation granted to executives and key employees. A document referred to as the grant agreement specifies the executive’s rights and employer’s responsibilities. At the grant date, the executive owns the shares, but their ownership rights are limited until the shares vest. While the terms within a specific grant agreement may vary, standard provisions follow:
- The executive cannot sell or transfer the shares until the RSA vests, i.e., restrictions lapse,
- Restrictions may remain in place for a specified period or until a specific performance goal is achieved,
- The executive may have voting and dividend rights during the restriction period, and
- The awarded shares vest when the restrictions lapse or, in some cases, the executive dies before the shares vest.
Pros and Cons
- Actual shares of stock are issued to the executive.
- Unless specifically restricted, the executive can generally vote the shares and receive dividends.
- The employer may provide the RSA at no cost to the executive.
- If holding period requirements are met, appreciation may be taxed at long-term capital gain rates.
- The executive may not sell or transfer the shares until the vesting date.
- If terminated before vesting, the executive forfeits the shares.
Income Tax Issues
Three key income tax dates and common tax implications are summarized in the chart and discussion that follows.
- Generally, the executive recognizes no compensation income or capital gain at the award date.
- IRS rules specify that the restrictions prevent the executive from recognizing compensation income or capital gains until the shares vest.
- The executive recognizes compensation income at the vesting date (the date restrictions lapse) to the extent of the bargain element.
- The bargain element is the fair market value of the shares less the executive’s cost (if any).
- Compensation is subject to income tax, Social Security tax (within annual limits), and Medicare tax.
- The executive’s income tax basis in the shares is increased to the extent of compensation income recognized.
- After the vesting date, appreciation in the shares is taxed as capital gain when the shares are sold.
- Long-term capital gains rates apply if the shares are held for more than one year from the vesting date.
Discerning financial advisors and planners with executive clients (or an aspiration to build an executive client-based practice) need competence and confidence in restricted stock award planning, especially in today’s intensively competitive advisory market. As just one example, there are income tax strategies that could slash RSA-based income taxes by almost half. Greene Consulting offers training in a comprehensive suite of equity-based compensation and income tax planning strategies.
To learn more about Greene Consulting and how we can help you succeed email Rick Swygman at email@example.com.
The information presented herein is provided purely for educational purposes and to raise awareness of these issues; it is not meant to provide and should not be used to provide investment, income tax, or financial planning advice of any kind. An experienced and credentialed expert should be consulted before making decisions relating to the topics covered herein. There are variations, alternatives, and exceptions to this material that could not be covered within the scope of this blog.