What are your options when it comes to stock options (no pun, intended)? We live in the city by the Bay, the great San Francisco Bay Area, stretching from Marin in the North to Silicon Valley and San Jose to the South: probably the world’s greatest area of technology innovation, and probably also the world’s greatest concentration of tech millionaires and wannabe millionaires. One of the tactics given by Bay Area companies is “stock options.” But these can be complicated both for employees and for employers; we advise many Bay Area startups as the city’s top CPA firm for startups. Here are some quick thoughts on RSU (restricted stock options).
Restricted stock and RSUs: How are they taxed?
Over the last seven years, restricted stock and restricted stock units (RSUs) have grown in popularity as incentive compensation tools, while the use of stock options has declined. So it’s important — for employers and employees alike — to understand their tax implications.
A restricted stock award is a grant of common stock that’s nontransferable and subject to forfeiture until it has vested. Typically, vesting requirements are tied to continued employment, achievement of pre-established performance goals or both. An RSU is a contractual right to receive stock (or its cash value) after the award has vested.
Advantages over options
For employers, stock options used to have a big advantage over other incentive compensation tools: They enabled companies to provide executives and other employees with valuable benefits without recording compensation expense on their financial statements. This advantage disappeared after the Financial Accounting Standards Board (FASB) amended its accounting standards for “share-based payments” in 2004, requiring companies to estimate the fair value of stock options on the grant date and report that value as compensation expense.
Options remain an attractive benefit, offering significant upside potential for employees. But restricted stock and RSUs also have some advantages. For example, they generally retain value despite market volatility, whereas options can become worthless in a down market. Also, from the employer’s perspective, restricted stock and RSUs generally involve fewer shares, so they cause less ownership dilution.
Sizing up the tax benefits
Restricted stock provides an attractive — but risky — opportunity for employees. If they make what’s known as an “83(b) election” to pay tax on the stock’s market value when they receive it, they can convert any future appreciation in value into long-term capital gains, which enjoy more favorable tax treatment. But it can be risky because, if they ultimately forfeit the stock, they’ll have paid tax on income they never receive.
Got questions? Call or email us for a free consultation on your tax planning needs!