Restricted Stock Awards (RSA)

Are you looking for a way to motivate your employees to work harder for your company? Nowadays many companies are exploring the role of equity compensation and the added benefits these bring. These compensation plans normally include restricted stock awards (RSAs), restricted stock units (RSUs), or stock options like NSOs or ISOs.

What are Restricted Stock Awards?

Restricted stock refers to the ownership in the company that is unregistered, and given out to corporate management, including executives and directors. Restricted stock is also referred to as “letter stock” and “section 1244 stock”. However as these restricted stock awards are not officially registered in the company shareholdings, they cannot be transferred.

Restricted stock awards are given to the seniors in the company, usually at the time of them joining the firm. This allows them to become a shareholder in the company and get some voting rights. And even though the stock option might have a strike or purchase price, it would usually be far below the company current stock’s value.

Whatever the case may be, RSAs still have restrictions, usually as per a vesting schedule. So, if a person is awarded the stock on their first day of joining the company, they cannot sell the stock until they have met all the conditions in the plan’s vesting agreement.

These stocks have to be offered following the special Securities and Exchange Commission (SEC) regulations. SEC regulations are in place for the company by adding restrictions on the stock so that the premature selling of the stocks can be deterred. This means that the restricted stock normally becomes available for sale under a graded vesting schedule over several years.

There are two kinds of restricted stocks, namely restricted stock awards or RSAs, and restricted stock units or RSUs.

What is the difference between Restricted stock awards and Restricted stock units?

There are two variants of restricted stock, including restricted stock awards (RSAs) and restricted stock units (RSUs). So, what makes them different?

A restricted stock unit is a simple promise made to an employee by the company to grant a specific number of shares at a predetermined time in the future. Since RSUs are not actual stock and just a promise to offer stock in the future, they do not have any voting rights. RSUs have to be exercised before the employee can get the stock, and once the RSUs have been converted, they have the standard voting rights as per the class of stock issued.

How do restricted stock awards work?

As soon as an employee gets a restricted stock award, the employee has to decide if they want to accept or decline the grant. And if they accept, they normally have to pay the employer the purchase price of the grant. After the employee has given the payment and accepted the grant, they will have to wait until the grant vests.

Vesting schedules for RSAs are usually either performance-based, which are tied to the accomplishment of some goals, or time-based, which is the stated period from the grant date till when the employee gets the benefits. When restricted stock awards vest, the employee gets the equivalent cash based on the company’s stock price or the shares of the company stock without restrictions.

Vesting in restricted stock awards

Put simply, vesting means that the receiver has to earn the shares over time. And as the employee legally owns the RSAs when they are granted, vesting in this case only impacts when the shares are repurchased from the employee as they leave the company. In short, a vesting schedule helps in ensuring that the person stays in the company for a long time.

Many companies have vesting plans in place for restricted stock awards to prevent individuals from joining a company, taking the rewards, and leaving instantly. And the rules of the vesting plan are decided by the company. If the employee leaves in between before the vesting period is over, they would lose their shares as the company will either take it back or repurchase the amount vested.

For example, let us say that Amy has been working for a company and has become a trusted senior staff. To appreciate her work and keep her for a longer time, the company decides to offer her some RSAs. Amy gets 2,400 RSAs that have a 4-year vesting period and a 1-year cliff. The restrictions placed on these shares are time-based, which meant that Amy had to stick with the company for 4 more years to get the full rewards. Here is how the shares would vest:

As you can see in the table, Amy gets her first cut of 25% of shares after one year due to the 1-year cliff period. After that, she gets the shares on a monthly basis for the rest of the 3 years, which is 50 shares per month. At the end of each year, she would have 600 more shares. And after the 4 years end, Amy would own the full 2,400 RSAs, and she can choose to sell these back to the company for cash.

Eqvista & Vesting

Eqvista is a cap table application that allows you to easily manage and track all the shares in your company. In addition to issuing shares electronically, you can also apply customized vesting schedules to each of your share grants.

Creating a vesting schedule on Eqvista is easy. After you have created the equity class and the restricted stock awards plan, you can also create and apply the vesting plan. All you need to do is log into your account on the app and go to your company’s dashboard. From here, follow these steps:

Step 1: From the side menu, click on “Cap Table” and then “Vesting Schedule”. You will reach the page where you can create the vesting plan. Here click on, “Create Vesting Plan”.

Step 2: You will be taken to the next page where you will have to select the plan type (from time-based, milestone-based or hybrid). After that, a drop-down page will appear where you need to add in the details of the vesting plan. Once you do this, click on “Submit”.

Step 3: And with this your vesting plan is created on Eqvista. You will be directed to a page where you can see all the plans. These plans can then be implemented while issuing RSAs to your employees.

How are restricted stock awards taxed?

Restricted stock awards allow the holder to take advantage of the so-called “83(b) election”. As per this tax election, the employee can report the stock award as ordinary income in the year they get it and then start the capital gain holding at that time. This allows the employee to pay less tax as compared to the normal income tax that has to be paid if they do not choose the 83(b) election. But the drawback to this is that if the stock price drops, the employee does not get any refund on the tax paid.

The alternative is to defer the paying of taxes until all the stock has been vested completely. As per the federal income tax rules, an employee awarded the restricted stock award is not taxed at the time of the grant, if they do not choose the 83(b) election. This means they will have to pay the normal income tax on the amount gained.

Now, based on the restricted stock awards plan, an employee who decides to avoid the 83(b) election would have two ways to meet their tax withholding obligation due at the vesting time – net shares or pay cash. Individuals who elect to net shares will have the appropriate number of shares withheld at vesting to cover their tax obligations. And the rest of the shares would be given to them.

And those who choose to pay cash for the tax withholding obligation need to have the appropriate amount of cash to give on the vesting date. They will need to give it to the company to report and remit the amount to the appropriate regulatory agencies.

Section 83(b) election

As per section 83(b) of the IRC, employees can change the tax treatment of their restricted stock awards. They can make the special tax 83(b) election where they will pay tax as soon as they are granted the award. This amount is the difference between the stock price at the time of the grant and the amount paid for the award (if any). The amount would then be withheld by the company the moment the restricted stock awards are given to them.

To make this election, the employee will have to file the Special Tax 83(b) election with the IRS within 30 days after the grant date. A copy of this form also has to be given to the employer and the employee would also need to share a copy of it when they file their income tax return.

Section 83(b) example

Let us assume that Jack elects for Section 83(b) on an award of 200 shares where the value for each share is $10. Jack was offered the RSAs for free, which means that he did not have to buy the shares when received. Since Jack was offered the shares for free, he will have to pay income taxes on the taxable gain, which in this case is $10 per share, so a total value of $2,000 in value. Assuming an ordinary income tax rate of 30%, he would need to pay $600 in ordinary income tax. This may seem like a lot of money upfront, but in the end Jack will pay less for his RSAs.

Now when the shares vest, the price of the shares increases to $20. If Jack had not elected for section 83(b), he would have had to pay income tax on a value of $4,000. He would end up paying $1,200 (30% of $4,000) in tax, which is double what he paid already. Thanks to the choice he made, he does not have to pay any income tax after the shares vest.

Then when Jack finally decides to sell the shares, he would have to pay the capital gains tax on the amount he earns from selling the shares. Let us assume that he waits for a little longer and decides to sell the shares when the price of one share is $40. In this case, he would have earned a profit of $8,000 ($40 * 200 shares) and he will have to pay the capital gains tax on the amount $6,000 (Capital gain – Amount gain on the grant day = $8,000 – $2,000). Assuming the capital gains rate of 15%, Jack would have to pay $900 ($6,000 * 15%) as capital gains tax.

If Jack had not taken the 83(b) election and decided to sell the shares after holding them for a while, he would have to pay capital gains tax on an amount of $4,000 (Selling price – the vesting price = $8,000 – $4,000). The reason why the tax is placed on $4,000 is because income tax would be paid on the value up to the vested date, ie. $4,000. The rest of the amount from the selling price would be considered as capital gains. So Jack would be paying a capital gains tax of $600 without the 83(b) election.

Let us see the difference Jack pays in tax with both scenarios:

(Assume an ordinary income tax rate @ 30% and capital gains tax rate @ 15% )

How can Eqvista help you?

Now that you are clear about how restricted stock awards work and you want to offer them to the employees in your company, just ensure that you keep track of the plan. You can use Eqvista to keep an eye on your company shares and have everything taken care of through the app, including things like the issuance of restricted stock awards and setting up vesting schedules.

Begin to take advantage of our equity software today. In fact, it is FREE to use, so check it out here. And If you need help on how to use or navigate around the app, check out our support-based articles. You can educate yourself to become a better founder by following our knowledge center!