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Restricted stock , also known as letter stock or restricted securities , is stock of a company that is not fully transferable from the stock-issuing company to the person receiving the stock award until certain conditions restrictions have been met. Upon satisfaction of those conditions, the stock is no longer restricted, and becomes transferable to the person holding the award.
Restricted stock is often used as a form of employee compensation, in which case it typically becomes transferrable " vests " upon the satisfaction of certain conditions, such as continued employment for a period of time or the achievement of particular product-development milestones, earnings per share goals or other financial targets.
Restricted stock is a popular alternative to stock options , particularly for executives , due to favorable accounting rules and income tax treatment. Restricted stock units RSUs have more recently become popular among venture companies as a hybrid of stock options and restricted stock. RSUs involve a promise by the employer to grant restricted stock at a specified point in the future, with the general intention of delaying the recognition of income to the employee while maintaining the advantageous accounting treatment of restricted stock.
Typical vesting conditions for restricted stock awards in venture capital —backed startups may include the following: Executive compensation practices came under increased congressional scrutiny in the United States when abuses at corporations such as Enron became public.
Prior to , stock options were a popular form of employee compensation because it was possible to record the cost of compensation as zero so long as the exercise price was equal to the fair market value of the stock at the time of granting.
Under the same accounting standards, awards of restricted stock would result in recognizing compensation cost equal to the fair market value of the restricted stock. However, changes to generally accepted accounting principles GAAP which became effective in led to restricted stock becoming a more popular form of compensation.
Under Section 83 of the Internal Revenue Code , the value of property transferred in connection with the performance of services is included in gross income, and is recognized as such on the date on which the property is no longer subject to a substantial risk of forfeiture, or the date on which the property becomes transferable, whichever is earlier.
In the case of restricted stock, the former date is generally known as the "vesting date" and is the date when the employee recognizes income for tax purposes assuming that the restricted stock is not transferable at an earlier date, which is how employers generally structure their restricted stock awards.
Employees pay income tax on the value of the restricted stock in the year in which it vests, and then pay capital gains tax on any subsequent appreciation or depreciation in the value of the restricted stock in the year in which it is sold. A grantee of restricted stock may make an "83 b election" to recognize the income from the restricted stock grant based on the fair market value of the restricted stock at the time of the grant, rather than at the time of vesting.
Revenue authorities in the United Kingdom and the Republic of Ireland have issued guidelines on the taxation of restricted stock and RSU awards. Restricted stock is generally incorporated into the equity valuation of a company by counting the restricted stock awards as shares that are issued and outstanding.
This approach does not reflect the fact that restricted stock has a lower value than unrestricted stock due to the vesting conditions attached to it, and therefore the market capitalization of a company with restricted stock outstanding may be overstated.
However, restricted stock has less of an impact than stock options in this regard, as the number of shares awarded tends to be lower and the discount for illiquidity tends to be smaller. From Wikipedia, the free encyclopedia. Restricted Stock and RSUs". Retrieved 19 August Archived from the original PDF on 30 June What employees and employers should know".
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