What is Foolsaurus?

It's a glossary of investing terms edited and maintained by our analysts, writers and YOU, our Foolish community. Get Started Now!


The Tax Implications of Selling Restricted Stock

Original post by Eric Feigenbaum of Demand Media

Employees and executives must report restricted stock as income when it is vested.

Companies have found that giving their employees stock not only is a low-cash form of compensation, it increases employee and executive interest in their company's success. Many organizations issue restricted stock as part of employee and executive stock-purchase plans and compensation packages. Restricted stock, unlike other forms of securities, is not subject to capital-gains taxes. Instead it is counted as income.

Contents

Income Tax

Restricted stock counts as income in the year in which it is vested. An executive or employee might be awarded stock options or a grant of restricted stock in a certain year, but if the vesting schedule takes three years, taxation is delayed by three years. Whether a person keeps the stock or sells it, taxes are based solely on the worth of the stock at the time of vesting. This value, minus anything the employee paid for the stock, becomes part of her taxable income for the year.

Selling

Holders of restricted stock pay no capital gains taxes upon sales, because they already paid income taxes on the stock, so the government already has made money from the gain. This gives restricted stock recipients less incentive than other investors to hold onto their shares.

Net Effect

The large increase of income in the vesting year can greatly increase the taxes that the person owes. Depending on the value of the stock at the time of vesting, a person's income can easily double or triple -- pushing him into a much higher tax bracket. A person wanting to hang on to his restricted stock should plan to pay more tax than normal in advance. Otherwise, he might need to sell to cover the tax burden.

Legalities

Restricted stock gets its name because it cannot be sold on the open market, per Securities and Exchange Commission Rule 144. However, holders of restricted stock are allowed to profit. To sell, a stockholder must register restricted stock with the SEC. This makes the stock public and allows a broker to sell it on an exchange.


                   

References

About the Author

Eric Feigenbaum started his career in print journalism, becoming editor-in-chief of "The Daily" of the University of Washington during college and afterward working at two major newspapers. He later did many print and Web projects including re-brandings for major companies and catalog production.

Photo Credits

  • Photos.com/Photos.com/Getty Images


Advertisement