Ask the accountant: What taxes will I owe on restricted stock?

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Green eyeshadesThis week’s tax question:

I’m used to getting stock options, but my new employer offers restricted stock instead. Does this change what I’ll owe in taxes, and do I need to do anything now?

We passed the question on to Steve Henley, national tax practice leader at CBIZ MHM, the seventh largest accounting provider in the U.S. Here’s his answer:

The receipt of restricted stock as part of compensation results in tax consequences that depend upon whether the taxation is delayed to a future year or whether a special election is made to be taxed in the current year.

Generally, restricted stock received by an executive contains certain restrictions, the most common of which being that the employee doesn’t “earn” full rights to the stock until he or she has satisfied a vesting requirement, which is often three years. The employee will not be taxed on the value of the stock until the vesting requirement has been met. Under this circumstance, the stock is taxed to the executive at the time the vesting requirements are met at the current value. For example, if the restricted stock is granted in 2011 and the vesting period is three years, the general rule is the stock will be taxed to the executive at the value of the stock in 2014, which may be considerably higher. Also, the value of the stock is taxed at ordinary income tax rates — not capital gain rates — because the tax rules consider the stock to be compensation and ordinary income, just like the executive’s salary.

However, the employee could make a Sec. 83(b) election with the IRS within 30 days of the stock grant. The value of the stock will then be included in the executive’s tax return at that time (i.e. in 2011 rather than 2014). The value of the stock will also be treated as ordinary income ($1,000 in the example above) rather than the value at the end of the vesting period. If the stock increases in value after receipt, then upon a future sale the increase in value will be taxed at the favorable capital gain rates, which are currently 15 percent for federal purposes versus the current maximum ordinary rate of 35 percent. Assuming the stock value increases, the employee benefits significantly by making the election. The employee could also claim a capital loss if the stock value decreases after the election and is lower at the time of sale. A capital loss is generally not very beneficial because it can only offset capital gains, except to the extent of $3,000.

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