Restricted stock and restricted stock units (RSUs) -- they’re the same thing, right? This is one of the most common misconceptions about these equity vehicles. Actually, use of these two types of equity grants could lead to very different outcomes for both the grantor and recipient.
As many organizations seek to improve their “pay-for-performance” compensation philosophy, they often create long-term incentive plans that allow executives and employees to earn additional compensation in the form of equity. Typically, equity is earned though the achievement of organizational and/or individual performance goals or through remaining employed with the organization for a specific period of time. If planned correctly, these plans will allow organizations to attract and retain organizational talent while allowing executives and employees to share in the organization’s success.
Restricted stock and RSUs are two of the most common equity vehicles today. Restricted stock is an equity vehicle that transfers the stock to the recipient on the date of grant subject to certain vesting restrictions. Unlike restricted stock, the key difference is that RSUs are not an actual transfer of stock on the grant date but rather a commitment to transfer stock or cash equivalent once vesting conditions are met. Below are other important differences between the two equity vehicles:
Section 83(b) election
Another difference between restricted stock and RSUs is the ability to make an 83(b) election. An 83(b) election is available for restricted stock but not for RSUs. An 83(b) election allows recipients to recognize ordinary income on the restricted stock transferred at grant, rather than recognizing income when they vest. This would allow for the recipient to receive favorable capital gain tax treatment on any gains that arise subsequent to the grant date. However, if a recipient makes an 83(b) election but ultimately does not vest, the recipient is not allowed a tax deduction for the income that was recognized in connection with the 83(b) election.
Another key difference between restricted stock and RSUs is the taxability of the grants to the recipients. As discussed above, the taxability of restricted stock depends on whether an 83(b) election has been made. If an 83(b) election is made, the recipient is subject to ordinary income tax on the fair market value of the restricted stock on the date of grant. The recipient is subject to capital gain or loss treatment when stock is sold. If no 83(b) election is made, the recipient is subject to ordinary income tax on the fair market value on the vesting dates. The recipient will receive capital gain or loss treatment upon selling the stock for any changes in value subsequent to the vesting dates.
For RSUs, the taxability depends on whether the units are settled in cash or stock. If the units are settled in stock, the recipients recognize ordinary income at the fair market value on the date the shares are transferred to the recipient. The recipient would receive capital gain or loss treatment upon selling the stock. If the units are settled in cash, the recipient recognizes ordinary income in the taxable year in which the participant actually or constructively receives the cash payment.
The last key difference between restricted stock and RSUs is related to the corporate deduction for these equity vehicles. Generally, restricted stock grants are deductible in the taxable year that contains the end of the calendar year when the recipient claims the income as compensation.
For RSUs, the deductibility depends on whether the units are settled in cash or stock. If the units are settled in stock, the deduction is based on when the stock is transferred to the recipient in accordance with the grantor’s normal method of accounting. This also applies if the units are settled in cash within 2 ½ months of the end of the grantor’s tax year in which the services were performed to earn the compensation.
If the units are settled in cash, but not within 2 ½ months of the end of the grantor’s tax year in which the services were performed to earn the compensation, the deduction occurs in the taxable year in which the payment occurs.
Organizations considering granting restricted stock or RSUs should think about the following when identifying the right grant type for their organization:
- What are goals the organization would like to achieve by granting equity to employees or service providers?
- What stage is the organization at in its growth life-cycle?
- Who would the organization like to grant equity to (i.e., all employees, executives, other service providers, etc.)?
- Is the Section 83(b) election an important feature to the organization and the recipients? Do the recipients understand the risks of an 83(b) election?
- Does the organization want the option of settling the grant in cash rather than stock?
- What other equity vehicles are available to the organization? Are restricted stock or RSUs the best options?
Deciding what type of equity plan to provide to your employees or service providers is a “facts-and-circumstances” decision. Organizations in different industries and at different points of their corporate life-cycle will have different scenarios to consider.
Ultimately, no matter which incentive vehicle is chosen, it is important that the plan would incentivize employees or service providers in helping the organization achieve their long-term goals, which aligns with the “pay-for-performance” compensation philosophy.
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