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.
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.
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.
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.
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.
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