Executives and other key employees are often compensated with more than just salary, fringe benefits, and bonuses: They may also be awarded stock-based compensation, such as restricted stock or stock options. Another form of compensation that’s becoming more common is restricted stock units (RSUs). If RSUs are part of your compensation package, you should be aware that there may be planning opportunities to defer your tax liabilities.
RSUs vs. restricted stock
Restricted stock plans grant stock shares to the employee. The shares are nontransferable and subject to forfeiture until they vest. The employee will recognize ordinary income based on the stock’s fair market value on the date that they vest. On the date of the grant, the employee can make a Section 83(b) election to recognize ordinary income based on the stock’s fair market value on date of the grant. By making the election, any future appreciation will be taxed at favorable capital gains rates.
The risk is that if the stock value declines or that the employee forfeits the restricted stock, the employee will have paid tax at ordinary income rates and be entitled to only a capital loss on the decline of value or possibly no loss on a forfeiture. After the employee recognizes the ordinary income (at the time the stock vests or with an 83(b) election), any future appreciation/depreciation will be recognized as capital gain or loss at the time the stock is sold.
On the other hand, RSUs are contractual rights to receive stock (or its cash value) after the award has vested. RSUs aren’t taxable until the employee actually receives the stock or cash. However, the employee is taxed at ordinary rates. Also, RSUs aren’t eligible for the Section 83(b) election.
Rather than having the stock delivered immediately upon vesting, you may be able to arrange with your employer to delay delivery. This will defer income tax and may allow you to reduce or avoid exposure to the additional 0.9% Medicare tax (by deferring the income to a year that you are below the threshold).
However, any income deferral must satisfy the strict requirements of Internal Revenue Code Section 409A. Section 409A restricts the ability of companies and employees to control the timing of nonqualified deferred compensation. Among other things, it requires that:
- The initial deferral election be made prior to the year in which the compensation is earned, and
- Payments be made according to a fixed schedule or tied to an event, such as death, disability, or termination of employment.
Violations result in immediate taxation of any vested compensation and a 20% penalty, plus interest.
If RSUs — or other types of stock-based awards — are part of your compensation package, please contact me at HZemel@berdonllp.com or your Berdon advisor. The rules are complex, and careful tax planning is critical.
Hal Zemel, a Tax Principal at Berdon LLP, New York Accountants, has more than 20 years in public accounting and advises businesses in the real estate, service, and manufacturing sectors.