Restricted Stock

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What is a 'Restricted Stock'

A restricted stock refers to unregistered shares of ownership in a corporation that are issued to corporate affiliates such as executives and directors. Restricted stock is nontransferable and must be traded in compliance with special SEC regulations. Also referred to as "letter stock" and "section 1244 stock," it typically becomes available for sale under a graded vesting schedule that lasts several years.

BREAKING DOWN 'Restricted Stock'

Restricted stock became more popular in the mid-2000s as companies were required to expense stock-option grants. Insiders are given restricted stock after merger and acquisition activity, underwriting activity and affiliate ownership in order to prevent premature selling that might adversely affect the company. An executive may have to forfeit his or her restricted stock if he or she leaves the company, fails to meet corporate or personal performance goals or runs afoul of SEC trading restrictions. The SEC regulations that govern the trading of restricted stock are outlined under SEC Rule 144, which describes the registration and public trading of restricted stock and the limits on holding periods and volume.

The taxation of restricted stock, governed by Section 1244 of the Internal Revenue Code, is complex. Restricted stock holders pay tax on the capital gain or loss represented by the difference between the stock’s price on the date it vests and the date it is sold. In addition, restricted stock is taxable as ordinary income in the year it vests. The amount that must be declared as income is the stock’s fair market value on the vesting date minus its original exercise price. However, the restricted stock holder may do a Section 83(b) election, which lets him or her use the price on the grant date, not the vesting date, for the purposes of calculating ordinary income tax. The tax bill must be paid sooner in this case, but it may be substantially lower if the stock appreciates between the grant date and the vesting date. The risk of taking this election is that if the restricted stock holder leaves the company before the shares vest, the shares are forfeited and taxes already paid are not refunded.

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RELATED FAQS
  1. What are restricted shares?

    Understand what a restricted share is. Learn why a company would issue restricted shares to employees and why an employee ... Read Answer >>
  2. What is cliff vesting?

    An employee is considered "vested" in an employer benefit plan, once they have earned the right to receive benefits from ... Read Answer >>
  3. How is trading volume regulated by the Securities and Exchange Commission (SEC)?

    Learn about how the SEC uses the trading volume formula as one requirement for an exemption to the ban on the resale of restricted ... Read Answer >>
  4. Can my company ever be entitled to take my 401(k)?

    Find out why your employer may be able to take part of your 401(k) if you leave your employment too soon, including how different ... Read Answer >>
  5. Why won't my broker allow me to sell one stock and buy another on the same day?

    There are two likely reasons why a customer would be unable to buy and sell a stock in the same trading day. For simplicity's ... Read Answer >>
  6. How do restricted stocks, treasury stocks and stock appreciation rights benefit employees?

    Restricted stock represents any equity that is conditionally given or sold to an insider as compensation or as part of an ... Read Answer >>
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