There are many ways to reward and retain talent in your organization and, one of those ways is by issuing equity and ownership options to your key employees. This has become a growing trend for that last 3 decades and more and more companies are offering various ownership options to their employees as a way to align their efforts with that of the organization and other stakeholders.
This article discusses restricted stock plans. So, what is a restricted stock plan and how does it work?
This plan provides an opportunity for employees to purchase shares at their fair market value, at a discount or even given the stock for free with specific restrictions.
Most often these restrictions are based on tenure with the company and the employees don’t actually own the stock until this time test is met. This time test can make the stock options available all at once or gradually and can also be contingent upon company, department or individual goals. Basically, restricted stock units or RSUs are like phantom stock that is settled in shares instead of cash.
As an employer, you benefit from the tax deduction for the amounts on which employees must pay income taxes whether a section 83(b) election is made or not. Ok, so what the heck is an 83(b) election and when is it a good thing to do?
From an employee’s perspective, when you’re given equity in a company as compensation you have to pay taxes on it just as if it was any other type of income from the company. The IRS requires you to pay taxes on the fair market value of the equity at the time it transfers to you in the year it actually transfers to you.
Typically, any grant of equity is going to be subject to some kind of vesting rules so again, you won’t actually pay any income taxes until it actually vests and, you pay taxes on the value of the stock at the time it vests. So, in other words, the higher the stock value goes, the higher the tax you’ll pay.
In comes the IRS’s implementation of code section 83(b) that lets you decide at the beginning of your vesting agreement to be taxed for the entire amount that will eventually vest at its present value. In other words, you write a letter to the IRS within 30 days of the grant being made to pay all the tax up front based on the value of the stock when it is granted to you. It’s a crap shoot but a good one for those who are gambling on the value of their granted stock to increase during the vesting period.
Come back next month for my third segment in this series to learn more about stock appreciation plans and stock transfer plans for closely held organizations. For more information on this and other tax and accounting topics visit my website at actservices-in.com.