We recently worked with an investor whose new job provided restricted stock as part of his compensation package. His concern was that owning the stock would disrupt his allocation—which it can, if not planned for properly. As we worked with him, he soon realized that allocation would not be the only disruption to his overall financial plan.
In a restricted stock program, employees are compensated with shares of company stock subject to certain restrictions, such as a vesting schedule tied to performance or tenure with the company. Generally, employees do not buy restricted shares like they would with stock options. Restricted stock is granted; therefore, regardless of how the company’s stock price fluctuates, the benefit nearly always carries a monetary value when it vests. One of the most important aspects of restricted stocks is how they are taxed. They are taxed when you take possession of the shares at vesting.
To complicate the tax situation further, it depends on if they are restricted stock units or restricted stock awards. Restricted stock awards are owned when granted, but the recipient must wait until the restrictions lapse before selling them. Awards provide the individual the right to purchase shares at fair market value, at a discount, or at no cost on the grant date. Any gain between the grant date and vesting is subject to ordinary income tax. The recipient may also owe capital gains on the growth of the shares between the vesting date and when sold.
Restricted stock units are owned the day the restrictions lapse according to the vesting schedule. They are a promise of future compensation. When the restrictions lapse, the IRS requires the employee to provide withholding of ordinary income tax; however, be advised that taxes can escalate quickly. For example, assume an employee has 1,000 shares that will vest at the end of the month. If the estimated closing price of the stock is $35, $35,000 will be included in his wages, subject to federal and state ordinary income tax and employment taxes. While the income tax can be paid by check, wire, payroll deduction, or by withholding shares, under withholding could be a problem.
Another potential pitfall with restricted stock is a lack of diversification. As shares vest and the stock grows, employees can develop a concentrated position with a large portion of wealth dependent on the performance of one company: the company that pays their salary and whose stock they own. Even if shares are sold immediately, investors should monitor how much they have invested in other stocks in the same industry. Furthermore, if the employee is a high-level executive, selling shares in bulk could be misconstrued by other investors.
Enlisting the help of a financial adviser and a tax consultant can help strategically plan for this type of compensation. If you have questions on restricted stock you may have, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
