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17.5 Income tax accounting for restricted stock and RSUs
Publication date: 31 Dec 2022
us Income taxes guide
Restricted stock represents shares that an entity grants to an employee and are generally subject to vesting conditions. If the employee fails to vest in the shares, the employee forfeits the right to the shares.
A restricted stock unit (RSU) represents an arrangement whereby an entity promises to issue shares at a future date if certain vesting conditions are met. RSUs do not consist of legally issued shares and are not outstanding shares, and therefore do not give the holder voting rights. Not all RSUs are alike; some can be settled in cash or shares, and some have terms that include anti-dilutive features.
Generally, restricted stock and RSUs generate a tax deduction to the employer on the vesting date because the employee has a substantial risk of forfeiture as a result of the award’s vesting condition until the vesting date.
Similar to the accounting for deferred taxes related to a nonqualified stock option discussed in TX 17.3, an entity recognizes a deferred tax asset based on the book compensation cost for restricted stock and RSUs over the requisite service period.
17.5.1 Measurement of tax deduction for restricted stock
The tax deduction for restricted stock and RSUs generally is measured as the restrictions lapse (i.e., as the employee vests in the award). At that time, the entity will determine if there is any excess tax benefit or deficiency by reference to the current stock price in relation to the grant date fair value.
17.5.1.1 IRC Section 83(b) elections
Under IRC Section 83(b), employees may choose to have the taxable income for certain equity interests received measured on the grant date instead of the vesting date. An IRC Section 83(b) election enables an employee to pay tax on the fair market value of a restricted stock award on the date it is granted rather than on the vesting date, as required under the normal rule of IRC Section 83(a). An IRC Section 83(b) election has no impact on the vesting provisions of the award or the pre-tax recognition of compensation expense.
From the employee’s perspective, the advantage of making an IRC Section 83(b) election is that any appreciation in the restricted stock after the grant date will be taxed as a capital gain instead of as ordinary income. If the stock appreciates in value after the grant, the capital gains treatment under this election can result in a significant reduction in the employee’s taxes.
For the employer, the consequence of an 83(b) election is that the employer’s tax deduction is fixed and claimable on the tax return at the grant date. If an employee makes an IRC Section 83(b) election, the entity would recognize a current tax benefit for the deduction and record a corresponding deferred tax liability reflecting the fact that the entity has received the tax deduction from the award before any compensation cost has been recognized for financial reporting purposes (the opposite of the nonqualified stock option scenario in which the book compensation cost is recognized in advance of the tax deduction). As the entity recognizes book compensation cost over the requisite service period, the deferred tax liability will be reduced. If an IRC Section 83(b) election is made by an employee for an equity-classified award (i.e., an award that is not remeasured for book purposes), there will be no excess tax benefit or deficiency upon settlement because the tax deduction would equal the grantdate fair value.
Example TX 17-2 illustrates the computation of book compensation cost and the corresponding deferred tax accounting for a grant of an equity-classified restricted stock award both with and without an IRC Section 83(b) election.
EXAMPLE TX 17-2
Income tax accounting for restricted stock
Income tax accounting for restricted stock
On January 1, 20X1, USA Corp granted 10 million equity-classified restricted shares that have a grant-date fair value of $15 per share and a three-year cliff-vesting requirement.
No forfeitures were assumed or occurred during the vesting period.
The stock price is $25 on January 1, 20X4, when the requisite service period is complete.
The applicable tax rate is 25% during all periods.
The entity recognizes compensation cost on a straight-line basis.
How should USA Corp compute the compensation cost and the deferred tax asset for restricted stock granted on January 1, 20X1?
Analysis
IRC Section 83(b) election by employee?
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Event / Date |
No |
Yes |
Grant date |
No entry |
Record a $37.5 million deferred tax liability and deferred tax expense, which offsets the current tax benefit (10 million shares × $15 grant-date fair value × 25% tax rate)
|
Recognition of compensation cost over the requisite service period (three years) |
Annual entry in 20X1, 20X2, and 20X3 to recognize a $12.5 million deferred tax asset associated with compensation cost recognized in advance of the tax deduction (10 million shares × $15 grant-date fair value ÷ 3 year service period × 25% tax rate) as book compensation cost is recognized
|
Annual entry in 20X1, 20X2, and 20X3 to reduce the deferred tax liability by $12.5 million associated with compensation cost deducted for tax purposes in advance of recognition for book purposes (10 million shares × $15 grant-date fair value ÷ 3 year service period × 25% tax rate)
|
December 31, 20X3 (conclusion of vesting) |
Deferred tax asset is now $37.5 million |
No deferred tax asset or liability |
Vesting date (January 1, 20X4) |
To record current tax benefit of $62.5 million ($25 fair value on vesting date × 10 million vested shares × 25% tax rate) and reversal of deferred tax asset. The excess tax benefit of $25 million is reflected in the income statement
|
No entry |
Under either alternative, the entity will recognize $150 million of book compensation cost over the three-year vesting period. However, the total tax benefit realized by the company will be capped at $37.5 million when the employee makes a Section 83(b) election. Without the 83(b) election, the employer is entitled to the greater tax benefit of $62.5.
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