Restricted Stock
Publication 525 - Quickfinder page 7-10
Ø What is restricted stock?
Restricted stock are shares in a company issued to employees as part of their pay, but which cannot be fully transferred to them until certain conditions have been met.
Example: John Doe is awarded 100 shares of XYZ company stock. However, before John Doe has the right to sell or transfer them he must work for the company another 3 years.
Ø What happens if the employee leaves their employers prior to vesting?
If an employee leaves before satisfying the vesting rules the shares are normally forfeited and returned to the employer.
Ø Are restricted shares taxed when they are received?
If stock received has restrictions, do not include its value in income until it becomes substantially vested unless the taxpayer makes an 83(b) election. Once the stock is vested, the taxpayer must report as income the FMV of the stock at the time of vesting minus – price paid (generally nothing).
Example: Jane Doe is awarded 1,000 shares of restricted stock on December 5, 2015 currently trading at $10 per share. She does not file an 83(b) election. The stock vests in three years on December 5, 2018, when it is trading at $30 per share. She will recognize $30,000 in ordinary (W-2) income in 2018.
Ø What is the 83(b) election?
Section 83(b) of the Internal Revenue Code permits an employee to elect to pay income tax on the fair market value of restricted stock (in excess of its cost, if any) in the year it is awarded, even though the stock may not be vested and is subject to substantial risk of forfeiture. The election must be filed with the IRS and your employer must be given a copy. One risk of filing an 83(b) election is that if your employment is terminated before the restricted stock vests, causing your unvested stock to be forfeited, you will not be entitled to a refund of the taxes you paid in the year of the award.
EXAMPLE: Jane Doe is given 1,000 shares of restricted stock on December 5, 2015, when the stock is trading at $10 per share. Within thirty days, she files a Section 83(b) election with the IRS. She will recognize $10,000 of ordinary (W-2) income in 2015. When the stock vests in three years at $30 per share in 2018, no ordinary income will be recognized.
Ø Can you review how the holding period works on Restricted Stock & how the income from the Restricted Stock will be reported to me?
If an 83(b) election is not filed, your holding period for determining long-term or short-term capital gain begins on the date the stock is vested. If an 83(b) election is filed, your holding period begins on the date the stock was awarded to you.
Your employer should report the ordinary income on your Form W-2. It should be included in Box 1 as part of your total wages and compensation, Box 3 (social security wages) as applicable, and Box 5 (Medicare wages). In addition, your employer may include it in Box 14. In the case of non-employees, the income will be reported on Form 1099-MISC in box 7.
Ø Can you discuss the new 83(i) deferral election for qualified equity grants?
The TCJA added IRC Sec. 83(i) allowing non-executive and non-highly compensated employees of a privately held corporation to elect to defer income up to five years for certain shares issued to them upon the exercise of nonqualified options or the settlement of restricted stock units (RSUs) if certain conditions are met. The provision is effective for stock attributable to options exercised or restricted stock units settled, after December 31, 2017. The election must be made within 30 days of when the stock became transferrable or vested.
The option or RSU must be granted by the corporation to the employee in connection with the performance of services and in a calendar year in which (1) no stock of the employer corporation is readily trade-able on an established securities market during any preceding calendar year and (2) the corporation has a written plan under which, in the calendar year, not less than 80% of all employees who provide services to the corporation in the U.S. are granted stock options or RSUs with the same rights and privileges to receive qualified stock (the 80-percent requirement).
If a Section 83(i) election is made, the income is taxed in the year that includes the earlier of:
1) The first date the qualified stock becomes transferable(generally in connection with the sale of the corporation)
2) The date the employee first becomes an excluded employee
3) The first date on which any stock of the corporation becomes readily traded on an established market
4) The date that is five years after the first date the employee’s rights in the stock are vested
5) The date on which the employee revokes the 83(i) election.
Ø What is a “Qualified Employee” and escrow requirements for an 83(i) election?
Pursuant to the authority provided to the Secretary under section 83(i)(3)(A)(ii), in order to be a qualified employee an employee making a section 83(i) election with respect to qualified stock must agree in the election that all deferral stock will be held in an escrow arrangement, the terms of which are consistent with the following requirements:
(i) The deferral stock must be deposited into escrow before the end of the calendar year during which the section 83(i) election is made and must remain in escrow until removed in accordance with clause
(ii) or the corporation has otherwise recovered from the employee an amount equal to the corresponding income tax withholding obligation under section 3401(i) for the taxable year determined in accordance with section 83(i)(1)(B). (ii) At any time between the date of income inclusion under section 83(i)(1)(B) and March 31 of the following calendar year, the corporation may remove from escrow and retain the number of shares of deferral stock with a fair market value equal to the income tax withholding obligation that has not been recovered from the employee by other means. The fair market value of the shares must be determined pursuant to the rules in § 1.409A-1(b)(5)(iv). The fair market value used for purposes of this calculation is the fair market value of the shares at the time the corporation retains shares held in escrow to satisfy the income tax withholding obligation. 16
(iii) Any remaining shares held in escrow after the corporation’s income tax withholding obligation has been met, whether by retention of shares in accordance with clause (ii) or otherwise, must be delivered to the employee as soon as reasonably practicable thereafter.
The Treasury Department and the IRS have concluded that the escrow arrangement described above adequately ensures the statutory income tax withholding requirements of the corporation will be met and that this approach is less burdensome than alternatives that would require a cash outlay by the corporation or the employee before the due date for the relevant withholding, and thus allow less flexibility with respect to resource allocation. If the corporation and the employee do not agree to deposit the deferral stock into an escrow arrangement consistent with the terms outlined above, the employee is not a “qualified employee” within the meaning of section 83(i)(3).