Both restricted shares and stock options are used in many different contexts in investing. If you're an employee, however, you're most likely to find them as part of your company's employee benefits package. Employers offer option grants company restricted stock as incentives for employees to meet goals, and to invest in the firm's future. Restricted shares and stock options each have their own structure and tax consequences.
Restricted shares are shares of company's stock that are attached to a set of specific trading rules. In employee benefit plans, the restriction is usually a time table, also known as a vesting schedule, which prevents you from selling the stock until after a specific time. Depending on how the company is set up -- whether it is publicly or privately held, for instance -- there may be other restrictions on selling the shares.
Stock options give the holder the right to buy stock at a particular price. In trading, the option is like a coupon and has an expiration date. As an employee incentive, it has a vesting schedule, or waiting period, before you can exercise it, and may only be valid while you remain with the company. Stock options also restrict the amount of stock you can buy at that price.
Benefits and Drawbacks
When a company grants restricted stock, the employee owns it right then and there. While he cannot sell it immediately, it has a known value and he can keep it if he changes employment. Restricted stock is always worth something, unless the company goes bankrupt, even if the stock price drops after the grant. Options are just possibilities -- they have no value until they are executed, and no benefit unless the market value of the stock is greater than the option price at the time of purchase. In addition, if the holder leaves employment before exercising the option, it usually becomes void.
Since a restricted stock has value on the day of the grant, you must pay tax on the market value of the stock when you receive it. The IRS considers the stock as compensation, so recipients must pay ordinary income tax unless they make a Section 83b election and pay tax within 30 days. Restricted stock dividends are also taxed at the ordinary income rate until the vesting period is complete. Stock options fall under two different sets of tax rules, depending on the type of option, but neither is effective until the option is actually exercised. Because you don't receive dividends until after the vesting period and purchase, dividends from stock bought with options are always taxed as dividends, and may be eligible for the beneficial long-term capital gains tax rate.
- Comstock Images/Stockbyte/Getty Images