By: Colleen Weber
Investment / News and Updates
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By Colleen Weber, CFP®, CPA
Executives are not compensated in the same way as regular employees. Their income is usually tied heavily to the value of their company because their compensation packages commonly contain restricted stock, not to be confused with restricted stock units (RSUs). Because of the complicated nature of restricted stock, employees who receive them need to plan ahead to consider the tax implications. Let this serve as a guide when planning to get the most value out of your restricted stock.
Restricted Stock vs. RSUs
Restricted stock, or restricted stock awards (RSAs), is a special type of stock subject to special restrictions, as the name suggests. Restricted stock is nontransferable and can be rescinded if certain conditions are triggered. A startup company may use RSAs as an early-stage strategy to incentivize loyalty, which can be advantageous for startups with lean cash reserves in the first few years. RSUs, by contrast, are like any other shares of stock after vesting and have no special restrictions.
Both RSAs and RSUs have no value to the employee until the time of vesting, and both incur tax liability in the year when they vest. The employee will need to factor in the taxes due, which could be substantial. An employee can alternatively opt to take a Section 83(b) election at the time the restricted stock or RSU is granted and pay tax at that time. The market price of the stock will then be treated as ordinary income at the time of grant, even though the stock has no value to the employee yet. The advantage to exercising this option is that the employee will not have to pay ordinary income tax at the time of vesting, which can result in a much lower tax bill. In any event, gains on the stock will still be subject to capital gains tax at the time of sale.
Restricted stock can often create a concentrated position for an employee. Diversification can be tricky with restricted stock. There are some strategies that allow an employee to diversify holdings without an outright sale, but some of these options may be difficult or impossible for a holder of restricted stock, depending on the specific terms and conditions laid out by the employer. If your restricted stock constitutes more than 10% of your overall portfolio, you should explore your options for finding ways to diversify holdings away from company stock if possible.
We Are Here to Help
Issuing shares of stock to executives is a great way to create a greater sense of ownership and reward loyalty. At the same time, employees who are issued shares as part of their compensation package often need to make important decisions that can affect their tax liability for years down the road. We also need to consider market volatility and all the other inherent risks that come with owning securities of any kind. If you hold or expect to receive restricted stock from your company, or if you would like an expert evaluation of your retirement plan, let’s connect. Book a free introductory meeting online or call (952) 470-0750 today.
Colleen Weber is a fee-only financial advisor, CERTIFIED FINANCIAL PLANNER™ professional, and CPA with more than 15 years of financial planning experience. Providing comprehensive financial planning and wealth management, she specializes in serving clients nearing retirement, retirees, busy professionals, and women. She is passionate about developing financial plans that save clients on taxes and investment strategies that help them pursue their goals. Learn more about Colleen by connecting with her on LinkedIn or booking a complimentary phone call meeting.