To reward key employees for either current or future performance, a company may give them shares of that company in the form of restricted stock. The company has the right to say when the employee can actually own the restricted shares by establishing a "vesting provision," or the stock will become his if he achieves certain goals. Once the employee owns the stock outright, the shares may or may not be taxable depending on the election that the employee has made.
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How Restricted Stock Works
First, the employee must agree to the offer. If he does, he might have to pay his employers a price for the stock. Then the employee must wait until the stock becomes his, whereupon he will receive either the shares of stock or their cash value depending on the rules made by the company at the time the plan was established.
Employee Pays Tax Now Or Later
Unless the employee make an election to the contrary by exercising his right under Section 83b of the Internal Revenue Code, the award will not be taxed until he has unrestricted rights to them. If he paid his employer for the shares when they are issued, he will pay income tax on the difference between their fair market value and what he paid for them. If not, he will pay the tax on the value of the stock at that time. If the employee exercises his rights under Code, he will pay income tax on the grant when it is issued, and be under no obligation to pay tax when the stock become unrestricted. However, he will possibly owe capital gains tax on the appreciation of the stock when he sells it.
If you think the value of the restricted stock will increase, it is best to pay income tax on the restricted stock award when it is received, because you will establish the cost basis of the shares by doing so, and the appreciation will be taxed as at lower capital gain rates when you sell it. On the other hand, if the value of the restricted stock is going down, you have lost your advantage by paying income tax at the time the restricted stock was awarded. Furthermore, you will need to come up with the tax money earlier, instead of simply selling enough shares later to pay it.
Paying The Tax
Assuming that you do not invoke your rights under Code Section 83(b), you can either take net shares or pay your tax in cash. By taking net shares, you are authorising the company to withhold shares amounting to the tax that will be due. If you prefer to pay cash, you need to have the amount due in your current account on the day the stock becomes unrestricted so your company can withdraw it and send it to the IRS.
It is imperative that you notify the IRS of your election of Section 83(b) within 30 days of the award. Also, before electing Section 83(b), realise that, if you leave the company and your restricted stock behind, not only can you not take a deduction for any loss in the stock's value, and you cannot claim a refund of taxes paid.
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