As we’ve previously discussed, one of the most important things to understand when your employer is acquired (or a pending deal has been announced) is how your unvested employer stock will be treated (i.e. the potential for accelerated vesting). While most people immediately jump to the windfall they’re expecting, most decline to think about tax liability until it’s too late.
Almost universally, people cringe at the thought of a large tax bill. That’s why it’s important to keep two things in perspective: taxes are an unpleasant symptom of financial success and increasing income, and your goal should be to avoid unintended tax consequences and costly mistakes.
In this article we’ll focus on a common mistake that is easily avoided (and can be reversed, even for prior years): paying taxes on the value of the stock you’ve received twice.
What’s special about restricted stock
Among employees at public companies, restricted stock (and RSUs, or restricted stock units) are more popular than stock options because their value tends to be more transparent. To some, restricted stock seems more like a non-cash deferred bonus – when it vests, it is “gifted” to you because you don’t pay anything to receive it. Here, you don’t have to worry about your options being underwater (which is what happens when they’re worth less than their purchase price) or investing cash out of pocket to buy them.
Even though you don’t pay anything to purchase restricted stock, you take ownership of shares on the date they vest, and their value on that day is treated as “ordinary income,” just like your regular salary.
For example, if 1,000 shares of restricted stock vested on January 3rd, and the price of your company’s stock that day was $25 per share, $25,000 in income would be recognized on your pay stub for that period, and it’s likely that taxes were withheld to cover this tax liability.
So where does the cash come from to pay these taxes? Well, restricted stock wouldn’t be very popular if people saw a huge chunk of their paycheck disappear during every pay period where restricted stock vested. In order to overcome this issue, and because employers are required to withhold taxes on restricted stock, it’s quite common for your employer to withhold a quantity of these shares equal to the value of that tax liability.
You already paid taxes on the initial value, so be sure not to pay again
The mistake most people make is that they rely on tax statements that you’ll receive from the broker where your shares are held. These brokers will report the “cost basis,” which is the original/initial value of the stock for tax purposes. (An increase above this amount would be considered a gain, and a decrease below this amount a loss.)
This information will be reported to you on Form 1099-B, which details stock transactions occurring in a brokerage account. In most cases, the cost basis reported by the broker where your shares are held will be reported as “$0.00”. Surely, the value of the stock when you received it was not zero (if it was, you wouldn’t be working there, nor would anyone else).
Now, you must be asking, “if the value of the stock wasn’t zero, why would they report incorrect data?” Well, the reason is that brokers are not allowed to report “cost basis” for securities where no money was paid for them. And since restricted stock is gifted to you without you needing to pay anything for it, it falls into this category. Without the correct information, the default figure is likely to be either blank or zero. This means that when you eventually sell the stock you’d be paying taxes on the entire value rather than just the increase since you received it.
As a result, it’s imperative that you make sure you track down from your employer what the actual cost basis is for your restricted stock so you can avoid this common tax mistake.
Doing it right, the first time
When it comes to restricted stock, people like that the value of what they’re receiving is more transparent than it is with stock options, and that they don’t have to decide when to buy them. But there certainly are nuances to restricted stock that need to be accounted for.
Many people fall into the habit of saying “I need to get through [life event], and then I’ll get the advice I need [now]”. Remember, engaging with a financial advisor is about navigating and delegating financial decisions and events to someone who has done it before, not adding to your already full plate.
If you have recently experienced a change in your financial situation, or would like a complimentary second opinion on your investments, please select a time for a 15-minute intro phone call to see how we may be able to help.
This blog was written by Jeremy Bohne, Principal & Founder of Paceline Wealth Management. Paceline is a fee-only investment advisor serving clients in the Boston area, and on a remote basis throughout the country. Paceline specializes in helping tech and biotech executives, physicians, and those seeking financial planning services.