Restricted stock compensation may have special tax implications
Be aware of your stock vesting schedule and its effect on your income tax bracket and rate
Always keep your financial-planning goals firmly in mind
Restricted stock and restricted stock units (RSUs) are simple in concept. You receive a grant of your company’s shares, subject to a vesting schedule. After the grant vests, you own the stock just like any other shareholder. But it’s important to understand the tax implications before you receive, and potentially sell, these shares.
Restricted Stock: Vesting and Taxation
First, make sure you have a solid grasp on the restricted stock grant’s vesting schedule. Give yourself ample time to assess your current tax situation and consult with your tax advisor. Why? Because when you receive shares upon vesting, the stock is considered income, with a taxable amount equal to the shares’ market value. And when you sell the shares later, you may be liable for capital gains tax on any appreciation since the shares vested.
Another key factor to investigate and understand is the way your company addresses the tax obligations related to the vesting of your restricted stock award. There are several approaches, and you may be able to choose (but not necessarily). Alternatives include withholding shares for taxes; selling a portion of the shares to cover taxes; taking a salary deduction; or simply making a payment. Because of these nuances, it’s critical that you take the time to understand any tax payment alternatives and consult with your tax advisor.
Be Mindful of Taxes and Timing with Restricted Stock
With restricted stock only (not with RSUs), you can make what’s called a Section 83(b) election with the IRS within 30 days after your grant date. With this election, you pay taxes on the value of the stock at the time it’s granted instead of the value at vesting. If you’re confident you’ll meet the vesting requirement and you believe the stock price will rise significantly by the vesting date, check with your tax advisor to see if it makes sense to pay taxes on the potentially lower value at grant and start the holding period for long-term capital gains.
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Your tax advisor can help you determine if a Section 83(b) election is appropriate for you. However, there are risks. For example, you cannot recover the taxes you paid if you later forfeit the grant by leaving your job before the vesting date.
Align Restricted Stock with Your Overall Financial-Planning Goals
Before determining a strategy for your stock awards, first consider your personal financial goals. Read “Three Things to Consider for Your Equity Compensation Plan” for a common-sense approach to including stock compensation in your overall financial plan.
With your goals in mind, try to anticipate what restricted stock or RSUs will mean for your taxes in the year of vesting, that is, when you actually receive the compensation. The income spike could have a significant impact on your tax obligations. If your default withholding is too low for your higher income that year, you may need to pay estimated taxes or set money aside to pay extra taxes when you file your year-end tax return.
Seek Professional Advice
Given the potential tax impacts of restricted stock and RSUs on your income, consult with your tax advisor to better understand your overall tax liability. You can also talk to a TD Ameritrade Financial Consultant about the role equity compensation plays in your overall financial picture. We’ll get you connected to the right professionals to help you maximize your investment and wealth strategies to align with your goals.
This article was developed with input from myStockOptions.com.
TD Ameritrade does not provide tax advice. Clients should consult with a tax advisor with regard to their specific tax circumstances.