3622 / What is restricted stock?

A restricted stock award, which is considered a funded Section 83 “transfer of property” for income tax purposes, is an outright grant of shares by a company to an individual, usually an employee, without any payment by the recipient (or for only a nominal payment). The shares of stock generally are subject to a contractual provision under which the granting company has the right (but not the obligation) to repurchase or reacquire the shares from the recipient on the occurrence of a specified event (e.g., termination of employment). This right of repurchase or reacquisition expires after a specified period of time, either all at once or in increments (for example, a grant of 1,000 shares with 200 shares vesting annually over a five year period). The expiration of this right is referred to as “vesting.” During the period that the shares of stock may be repurchased or reacquired, the recipient is prohibited from selling (or otherwise transferring) the shares. This is why the shares are called “restricted stock.” The passage of time typically serves as the primary restriction for such stock and is the normal substantial risk of forfeiture in the grant necessary to prevent current taxation under IRC Section 83 and also to claim the “short term deferral exception” to avoid Section 409A coverage. Restricted stock vesting may depend on restrictions other than time (e.g., satisfying corporate performance goals, such as reaching a specified level of profitability) that also might satisfy these requirements.

On May 29, 2012, the IRS released proposed regulations clarifying the definition of “substantial risk of forfeiture” under Section 83, and incorporating its ruling in Revenue Ruling 2005-48 (for details on the changes see Q 3538). On February 25, 2014, the IRS released final regulations that are substantially similar to the proposed regulations. These regulations apply to all transfers of property on or after January 1, 2013, though the final regulations may be relied on as to transfers after May 30, 2012.¹ Hence, they apply to restricted stock plans that usually achieve income deferral because they require substantial future service, which provides an adequate Section 83 “substantial risk of forfeiture.”

For the tax treatment of restricted stock, including the taxability of dividends on restricted stock, see Q 3623.