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The Difference Between Restricted Stock and Stock

Original post by Linsay Evans of Demand Media

Restricted stocks are generally limited to company insiders.

Restricted stocks, also called letter stocks or Section 1244 stocks, represent a category of investments governed by a special set of Securities and Exchange Commission (SEC) rules as set forth in section 1244 of the Internal Revenue Code (IRC). Unlike common stock, restricted stockholder’s rights are restricted until the shares vest. Sales of restricted stock must be registered with the SEC.

Restricted Stocks

Company insiders and officers are generally offered restricted stock after activities such as mergers, acquisitions, underwriting or affiliate ownership. If potential recipients accept the offer, they cannot sell the stock until the end of the vesting period, which can be based on company performance or a predetermined time frame. This prevents insiders from early selling that could harm a company. Once the vesting period ends, stockholders can treat the restricted stock as they would any other stock investment.

Common Stocks

In contrast, most common stocks don’t require a vesting period. Instead, ownership of common stock includes the choice to sell it at will. However, companies can place restriction on other types of common stock, usually by limiting holders’ voting rights. For instance, a company could grant three votes per share held to one class of stock owners and only one vote per share held to another class of stock owners. Companies often name such stocks class A or class B. Other types of stock include preferred stock which, unlike common stock, pays a guaranteed dividend.

Common Stock and Taxes

Common stock sales or losses can be taxed as capital gains or losses at the ordinary income rate. Tax treatment depends on a number of factors, though, such as amount of time the stock was held, whether the option price was below the stock’s fair market value at the time of granting and the stockholder’s income.

Restricted Stock and Taxes

Unless a restricted stockholder elects for special tax treatment under IRC 83(b), restricted stocks are not subject to federal income taxes until after the vesting period has ended. Under IRC 83(b), recipients claim the fair market value of the restricted stock at the time of granting rather than when the vesting period is over. An 83(b) election also triggers the immediate start of the vesting period, but does not make provisions for claims of tax loss in the case of forfeiture. In contrast, if a restricted stock holder leaves the company during the vesting period and does not claim the IRC 83(b) tax treatment, she can claim a loss for tax purposes and receive a refund for taxes already paid. Because restricted stock holders who do not take the IRC 83(b) election must pay taxes at the end of the vesting period, they can elect to pay cash or use net shares to fulfill their tax withholding obligations.

                   

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About the Author

Based in Phoenix, Linsay Evans has been writing professionally since 2004. Her experience lies in nonprofit grant writing and in community relations management. Her research has been published in "LIBRES" and the "University of Washington Policy Journal." Evans holds a Master of Library and Information Science and a Master of Arts in anthropology.

Photo Credits

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