In a restricted stock arrangement, an employer gives an employee the option to purchase restricted stock or simply grants the stock to the employee. Recipients cannot vest in the stock until the restrictions no longer apply. For example, the employee may have to forfeit the stock if he or she does not work for the employer for a set period of time. Another common restriction is that the stock cannot be transferred to another person.
Income Recognized When Restrictions Lapse
For federal tax purposes, the employee will not have to pay taxes on the income from restricted stock options until the restrictions lapse. If the restricted stock is subject to a restriction that will never lapse, the employee is taxed when the option is exercised. The income that eventually must be recognized for federal taxes is the difference between the fair market value of the restricted stock on the date the restriction lapsed and the cost of the stock to the employee.
Income From Restricted Stock Is Treated as Supplemental Wages
The difference between the fair market value of restricted stock and the cost to the employee is treated as a supplemental wage payment for withholding purposes. This amount is treated as wages for Federal Insurance Contributions Act and Federal Unemployment Tax purposes as well. The employer should report the amount of taxable income generated by a grant of restricted stock on the employee's Form W-2 in the year when the restrictions lapse.
Income May Be Recognized in Year of Transfer
However, an “IRC Section 83(b) election” allows the employee to recognize restricted stock compensation income in the tax year it is granted, rather than the year that the restrictions lapse. Employees must make §83(b) election within 30 days after the date that the restricted stock is transferred. As in regular restricted stock income recognition, the income is reported as supplemental wages on a W-2 and included in FICA and FUTA calculations.
Income is Difference Between Fair Market and Exercise Prices
In a §83(b) election, the amount of income that must be recognized by an employee is equal to the difference between the fair market value of the stock, and the amount paid for such stock on the transfer date. Employees can make a §83(b) election even if the fair market value of the stock equals the exercise price, resulting in zero income for tax purposes.
No Additional Reporting by Individual Is Required
According to the Internal Revenue Service, if as of December 31 of the applicable calendar year, the employer does not withhold the correct amount of income tax from the employee on supplemental wages from restricted stock grants, or withholds less than the required amount, the employee will receive credit for that calendar year if the employer corrects the mistake. No additional reporting by the employee on the individual Form 1040 is required.