How Is Restricted Stock Taxed?
Restricted stock is taxed as ordinary income, but the amount paid and time the taxes are due depends on whether you take a Special Tax 83(b) election. Restricted stock is also subject to any capital gains taxes at the time of sale. The laws surrounding restricted stock are purposefully strict due to the privileged knowledge typically possessed by the shareholder. These laws are in place to help prevent insider trading and increase market fairness.
Ordinary Income Tax
The default situation for restricted stock is for it to be taxed once it has vested according to the stipulations determined at the time the shares were awarded. After the stock is fully vested, ordinary income tax will be determined by the following formula:
Fair market value – original purchase price = amount of ordinary income
When the shares vest, the income must be reported and paid for the tax year of vesting. An exception is if the shareholder elects Special Tax 83(b), in which case the ordinary income tax is paid at the time the shares are granted. At this stage the cost basis has now been set. Any appreciation of the stock will be subject to capital gains tax if sold.
Reasons to Wait Until Restricted Stock is Vested
- Ensure your stock vests before paying taxes on it
- Have the liquidity to sell stock in order to pay for the taxes
- Have more time to save for your tax liability
- Hedge against the stock declining in value
Special Tax 83(b) Election
If a Special Tax 83(b) election is made, the ordinary income tax will be calculated based on the fair market value of the restricted stock at the time it is awarded.
Paying taxes upfront can yield significant benefits; however, due to substantial risk of forfeiture associated with restricted stock, as well as market volatility, electing Special Tax 83(b) poses financial risks as well. Before making a decision on when you will declare your restricted stock as ordinary income, it is important to weigh the pros and cons of taking a Special tax 83(b) election.
If you decide that the situation behooves making a Special Tax 83(b) election, the IRS must be notified within 30 days of the restricted shares being issued. The language used in the notification should mirror the sample text outlined on page 9 of this IRS document. You must also submit a copy to your employer and include a copy when filing your taxes.
Reasons to Take the Special Tax 83(b) Election
- If you believe your income will grow in the future, you may be able to achieve a lower tax rate by taking the Special Tax 83(b) election
- If you believe the stock will increase in value, you will set your cost basis earlier leading a lower tax rate paid with long term capital gains vs. ordinary income tax
Capital Gains Tax
In addition to ordinary income tax, restricted stock is also subject to the same capital gains taxes as standard securities. Restricted stock will be subject to capital gains taxes after a sale once the cost basis has been set by either the shares vesting or a Special Tax 83(b) election. The regulations surrounding restricted stock impose limits on the volume and frequency with which shares may be traded, but any time that shares are sold for a profit, the capital gains tax will apply. To understand the limits placed on trading restricted stock, you will need to familiarize yourself with Rule 144, which governs the trading of restricted stock and controlled securities.
Using an Exchange Fund to Diversify Risk and Save for Taxes
Restricted Stock shareholders can diversify their risk and save for their taxes using a unique new exchange fund. The Copper Moose Fund allows holders of restricted stock to leverage their illiquid assets for long-term growth while providing a first-year cash distribution that can be used to cover the long-term capital gains tax (up to 23.8%) that may be due on the constructive sale of the securities after exchange.
Learn more about The Copper Moose Fund at https://coppermoosefund.com/
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- Understanding Restricted Stock