Over the past 10 years, the structure of common stock option bonuses has shifted. This has been a result of changing accounting rules and regulations, and it has major implications for employees and companies of all shapes and sizes.
Two of the most popular stock bonus structures today are the restricted stock unit (RSU) and the restricted stock award. Let's compare and contrast to help you understand which is better for you.
What is a restricted stock unit?
Restricted stock units are a promise made to an employee by an employer to grant a given number of shares of the company's stock to the employer. Generally, RSUs are granted based on a vesting schedule, meaning the employer must continue to work at the company for a specified period of time before the full value of the RSUs can be awarded.
In some cases, particularly for higher ranking executives, RSUs can also be tied to performance goals either individually or at the corporate level, and they can also contain covenants that can terminate the RSUs if the employee is terminated for cause.
Generally, an RSU represents stock, but in some cases an employee can elect to receive the cash value of the RSU in lieu of a stock award.
Once RSUs are exercised and become actual shares of the company's stock, those shares come with standard voting rights for the class of stock issued. However, before the RSUs are exercised they carry no voting rights. This makes sense because the RSUs are themselves not actually stock, and therefore don't carry the same rights inherent to the stock itself.
RSUs are taxed as ordinary income as of the date they become fully vested, using the fair market value of the shares on the date of vesting.
What is a restricted stock award?
Restricted stock awards are similar to RSUs in many ways, but have their own unique differences as well. Like RSUs, restricted stock awards are a way for the company to reward employees with stock in addition to their cash compensation. Restricted stock typically vest over time and can be subject to termination if the employer is fired, quits, or fails to meet any performance objectives as stipulated in the stock award program.
However, the similarities largely stop there. Restricted stock awards come with voting rights immediately because the employee actually owns the stock the moment the award is granted. This is in contrast to RSUs, which represent the right to stock, as opposed to owning the stock but with restrictions. Also, restricted stock awards cannot be redeemed for cash, as some RSUs can be.
The tax treatment of restricted stock awards comes down to a choice by the employee. The employee can pay taxes similarly to an RSU award, with the fair market value of the restricted stock counted as ordinary income on the day of vesting. However, thanks to a rule called Section 83(b), restricted stock award holders can also elect to pay the ordinary income tax based on the fair market value of the stock on the day it is granted. This feature is beneficial to many highly compensated executives because it provides them with greater choice in their tax planning.
Sometimes, restricted stock awards require that the employee pay a certain amount in order to accept the restricted stock. In essence, the employee is paying for the shares, typically at a discount. This structure can reduce the tax burden for the employee because the taxes paid on the restricted stock award will be based on the difference between the value and the amount the employee paid, instead of the total value of the stock.
For employees without high salaries, this requirement can be a major issue with restricted stock awards. This is part of the reason why RSUs have gained popularity in recent years.
Every company and employee is different. Weigh your options as such
While similar in most regards, the differences between RSUs and restricted stock awards can have a major impact on how valuable a stock bonus can be. It's critical to consult with an accountant who has experience with various stock award structures to ensure you maximize the value of your RSUs or restricted stock based on your own personal situation.
If you want to learn more about stocks, including how to get started investing, head on over to our Broker Center. We have plenty of resources to help out, including lots of handy links to brokers who can start you on your investing journey.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at knowledgecenter@fool.com. Thanks -- and Fool on!
