investing

# Stock options, restricted stock and taxes

For example, you were granted an ISO on May 12, 2012, with the option to buy 100 shares of ABC Company stock at \$10 a share, which was the fair market value of the stock on May 12. You exercise the option on March 6, 2013, when the stock is trading at \$12 per share. You sell the stock on March 26, 2014, for \$15 per share. Let's look at the holding periods: You held the stock for more than one year, however, less than two years had elapsed from the date the stock was granted until the date it was sold. Therefore, in 2014 you must report the difference between the exercise price (\$10) and the value of the stock when it was exercised (\$12) as wages. The rest will be treated as capital gain.

## Calculating taxes on ISOs

Sales price \$15 x 100 shares = \$1,500

Purchase price \$10 x 100 shares = \$1,000

Total increase = \$500

Wages \$2 x 100 shares = \$200

Capital gain \$3 x 100 shares = \$300

Had the holding period been satisfied, the entire \$500 would have been treated as capital gain.

## Restricted stock

Restricted stock is a share of stock subject to certain restrictions such as the requirement that you remain employed for a period of time. When restricted stock is granted to you, the stock is issued in your name but with a legend entry reflecting the restriction. Once the restriction lapses (i.e., the stock vests), the restriction notation is removed. The fair market value of the share on the date it vests (less the amount, if any, you paid for it) is included in your wages and subject to federal income and employment taxes.

For example, you are granted 60 shares of restricted stock that vests Jan. 1, 2013. The fair market value of the stock on the day it vests is \$20 per share. On that day, \$1,200 will be included in your wages and subject to federal income tax at ordinary income rates and employment taxes.

It is possible to make an election to include the value of the shares on the date of grant in income. The benefit of this is that any future appreciation in the value of the stock will be taxed at capital gains rates. This election must be made within 30 days of the date of grant.

Turley says this election should be carefully considered. "Your election to accelerate the ordinary income tax associated with your restricted stock is irrevocable."

It gets complicated if, for example, your employment is terminated early or if the stock falls in value before the restrictions placed on the stock lapse. "You will have paid taxes on amounts that you may never receive," she says.

## Restricted stock units

Restricted stock units are a tad more complicated. RSUs are a promise to pay cash or stock at a future date. Each unit is based on the value of a share of stock. RSUs can be paid, either in shares or in cash, on a date later than the vesting date. The federal income tax event will occur on the date the cash is paid or the stock is transferred. However, employment taxes (Social Security and Medicare) are due on the vesting date.

Due to special rules that apply to nonqualified deferred compensation arrangements, says Wilkerson, "Payments made too early or too late could subject you, as the award holder, to significant adverse tax consequences."

Assume the RSUs are granted to you Jan. 1, 2012, and they fully vest if you remain employed through Jan. 1, 2016, but with a payment date of Jan. 1, 2017. You will be paid, either in cash or shares of stock, on Jan. 1, 2017. On Jan. 1, 2016, you will owe employment taxes on the fair market value of the cash or stock in which you were vested. On Jan. 1, 2017, you will include the fair market value of the cash or stock you are paid for federal income tax purposes.

Options, restricted stock and RSUs are beneficial, but each type is subject to different tax treatment. After you finish celebrating your award of equity-based compensation, make sure you understand how it works. You want to minimize the tax burden and keep as much of your hard-earned compensation as possible.

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