Publicly traded technology companies increasingly use restricted stock and restricted stock units (RSUs) to give employees ownership in the company. Restricted stock and RSUs are two of the simplest forms of equity compensation, and their relative simplicity is part of the reason for their popularity with companies and employees.
How They Work
Restricted stock is company stock that your employer gives to you as part of your total compensation, and you cannot sell or transfer it until certain conditions have been met. Typically, your ownership in the stock vests, meaning its restrictions are removed, over time or as company or individual performance goals are met. If you leave the company, you lose your unvested shares. Once your stock is vested and its restrictions are removed, you own the shares and may sell or transfer them.
Meanwhile, a restricted stock unit is a promise by your employer to transfer shares of company stock to you when certain conditions have been met. As with restricted stock, your restricted stock units vest over time or when company or individual performance goals have been met. If you leave the company, you lose your unvested units, and they cannot be exchanged for company stock. Once your RSUs vest and the company exchanges your units for actual shares of company stock (usually at a 1:1 ratio), you own the shares and can sell them or transfer them. Some RSUs are settled in cash, and some offer you the option of receiving shares or cash.
The day on which your company gives you restricted stock or restricted stock units is the award date or grant date. Your company’s stock plan administrator makes your restricted stock and RSU information available to you through a website operated by the brokerage firm providing stock plan services to your company. Your company will ask—and may require—that you “accept” your restricted stock or RSU grant. By accepting your grant, you instruct the company how you would like required taxes withheld.
Restricted stock and RSUs typically vest monthly or quarterly for three to five years with a one-year “cliff.” A one-year cliff means that either 12 months or four quarters of vesting complete all at once at the end of the first year. For example, an RSU that vests quarterly over three years with a one-year cliff will be 33% vested at the end of one year and will then vest one-eighth of the remaining amount each quarter over the next two years.
Vesting encourages employees to stay with the company. If you leave before your vesting is complete, you will lose the portion of the restricted stock or RSUs that have not vested.
Once you receive shares of stock from the company, either because of the removal of restrictions on restricted stock or because of the conversion of RSUs to actual shares, you have several options. You can continue to hold the shares, you can transfer them to another brokerage account and hold them or sell them, or you can sell them and transfer the cash to a bank account.
How Are They Different?
The main difference between restricted stock and restricted stock units is that with restricted stock you receive shares of stock up front whereas with RSUs the company pledges to transfer shares of stock to you in the future.
Restricted shares typically have voting rights and are entitled to receive dividends. RSUs are not actual shares; therefore, they do not have voting rights and are not entitled to receive dividends. Some companies pay RSU holders an amount equal to the dividends they would have received if they held actual shares.
For most people, the difference between receiving restricted stock and RSUs is negligible—with both, you own company stock after a vesting period.
What Are They Worth?
The value is easy to calculate. Multiply the number of shares or units (assuming a 1:1 conversion ratio of units to shares) by the current stock price of the company. The result is the total value of your restricted stock or RSU. Your online account may break down the value further into vested and unvested portions.
Unlike stock options, which can be worth nothing if the company’s stock price is below an option’s exercise price, restricted stock and RSUs have value if the company stock price is above $0.
Restricted stock is not taxable to you when you receive it. The stock becomes taxable to you as it vests. The market value of the shares you receive is taxable to you as ordinary income and is reported on your paystub.
Taxation of RSUs works similarly. When your RSUs vest, your company’s stock plan administrator exchanges your vested units for shares of your company’s stock and places those shares in your account. The market value of the shares that you receive is taxable to you as ordinary income.
Your company must withhold taxes from the income you receive in the form of shares. Because you receive income in the form of shares and not cash, there is no cash available to withhold for taxes. To work around that issue, most companies either withhold some of your shares to pay taxes or automatically sell some of your shares to pay income taxes.
Your restricted stock and RSU income is subject to payroll taxes in addition to federal and state income tax. Payroll taxes include federal Social Security and Medicare taxes and potentially additional state and local taxes depending on where you live.
After you receive actual shares, your cost basis in those shares is their market value on the day you receive them. Taxation after you receive your shares follows the normal rules for gains and losses on investments.
Despite differences in their structure, restricted stock and RSUs are similar in their vesting, valuation, and taxation. Be aware of your vesting schedule to know when your shares will be vested and available for sale or transfer.
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