Simplifying Restricted Stock – What You Need to Know
Many companies offer restricted stock awards (RSA’s) in their executive compensation packages to drive performance and attract and retain top talent.
The challenge often lies with understanding the value and opportunities of these packages. Today we’ll discuss a very important but not-so-well understood topic, the 83(b) Election.
RSAs vs. RSUs
First, it’s important to note that the 83(b) election only applies to RSAs, which are different than restricted stock units (RSU’s) and not eligible. RSAs represent an actual stock transfer, while RSUs are a promise to transfer stock once vesting conditions are met.
The 83(b) election allows you to pay tax early; on the RSAs’ fair market value at the grant date versus down the road when they vest. If no election is made, the recipient is subject to ordinary income tax at vesting.
Timing is Everything
The election must be filed with the Internal Revenue Service no later than 30 days from the date of grant. It’s critical to make the election in a timely fashion. If you miss that 30-day window, you’re out of luck.
When it Makes Sense
The goal of this strategy is to pay less tax now vs. later, should the stock increase in value. As with any strategy, however, the circumstances must be carefully considered.
If the grant you receive has little value, it makes more sense to elect 83(b).
- Consider this example: 100,000 shares worth $0.01/share when granted. If you make an 83(b) election, you pay ordinary tax on $1,000 (the grant value) and nothing at vesting, only on the sale at capital gains rates.
- Let’s say the stock appreciates to $2/share at vesting with no 83(b) election. You would have $200,000 of ordinary income subject to tax at vesting, plus capital gains on any gains from that point forward if sold.
When it Doesn’t
If the grant value is larger, the decision becomes more difficult. You should carefully consider the potential risks before making this election:
- What if the grant value in the above example is $100,000? Assuming a 37% rate, now you are looking at a $37,000 tax bill to make the election.
Here, you not only have to come up with the funds to pay the tax, if the company fails or the stock value drops, you could also pay tax on something potentially worthless.
Another risk is if the stock doesn’t vest. For example, if your employment terminates before vesting. There is no deduction allowed for the income you recognized by making the 83(b) Election.
Can it be Undone?
No. With rare exception, the election is irrevocable.
It’s important to carefully balance how much the tax hit will be now vs. the upside to potentially receive later. Also understand this is a tax reduction strategy which can be adversely impacted by tax law changes.
You are exchanging paying ordinary income today for capital gain treatment later if the stock is sold. But if capital gain rates increase in the future, you may not save nearly as much or possibly nothing at all. Don’t forget state taxes as well. It’s important to run the numbers.
It’s also wise to understand the impact on your complete financial picture. Running “what-if” financial planning scenarios, where you can see how much risk you need to take to reach your goals, can help you make an informed decision.
Making decisions like these are never easy, so please reach out to us if we can assist in any way.
Gary K. Pattengale, CPA, CFP® is a Wealth Manager at BDF and is a member of the Firm’s Investment Committee. With 20-plus years of professional experience, Gary began his career as a public accountant, training that he uses to help his clients minimize their tax burden. He draws on his extensive experience to provide his clients with strategic insight into the planning and investment strategies most suitable to their circumstances. Gary earned a BS in Accounting from Northern Illinois University as well as the Certified Financial Planner™ and Certified Public Accountant designations. He is recognized as a FIVE STAR Wealth Manager by Chicago magazine, and is a member of the American Institute of CPAs and Financial Planning Association.
Gary is a Wealth Manager at BDF and member of the Firm’s Investment Committee. He specializes in executive and stock-based compensation plans, including stock options, restricted stock and deferred compensation. He combines his tax knowledge, executive compensation experience and capital markets expertise to help clients reduce their tax burdens and achieve each of their unique goals.