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Many firms pay a portion of their employees’ compensation in the form of restricted stock or restricted stock units.

Restricted stock is granted to executives. It’s nontransferable and subject to forfeiture under certain conditions, such as the failure to meet performance benchmarks. It typically becomes available under a graded vesting schedule that lasts several years. Usually, executives receiving it have insider knowledge, making restricted stock subject to insider trading regulations.

Restricted stock units, or RSUs, are an unsecured promise by the employer to grant a set number of shares to an employee upon the completion of a vesting schedule. Generally, the stock is not issued until underlying covenants are met.

Restricted stock usually becomes taxable upon the completion of the vesting schedule. If a shareholder sells the stock after the vesting time, any difference between the sale price and the fair market value on the vesting date is a capital gain or loss.

Restricted stock shareholders can also declare their shares as ordinary income on the date the stock is granted instead of when they become vested. This is Section 83(b) treatment. It can reduce the taxes owed because the stock price at the time of granting is often lower than when it becomes vested.

Section 83(b) is risky, however. If the shareholder leaves the company before becoming vested, he loses all rights to the stock balance even though he has declared the stock as income.

With RSUs, Section 83(b) treatment is not permitted. The value of the stock can only be declared at vesting, at which point its value is the fair market value. It’s reported as ordinary income.

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