Employees, as part of stock-based compensation awards, may be entitled to receive dividends on their awards during the vesting periods or, in the case of options, during the period until the exercise of their options (so-called “dividend protection”). The grant date fair value (i.e., stock price) of dividend-paying restricted stock awards or RSUs already contemplates the expectation of future dividends; therefore, no adjustment is needed to the grant date fair value of restricted shares (or RSUs). ASC 718-10-55-44 provides guidance on the accounting for the dividend rights and states that the dividend protection should be reflected in the estimated fair value of the award ASC 718-10-55-45 states that the payment of dividends on restricted stock or options should be accounted for in retained earnings if the shares are expected to vest. When the related award is not expected to vest, and the employee is not required to return the dividend or dividend equivalents received if the underlying award is forfeited, the payment of the dividends or dividend equivalents are recognized as additional compensation cost. Any dividends or dividend equivalents that are forfeitable would not result in the recognition of additional compensation cost if the award is equity classified. All dividends paid on awards classified as liabilities are accounted for as additional compensation cost.

From a tax perspective, dividends paid to employees on restricted stock for which an employee has not made an IRC Section 83(b) election are not treated as dividends paid to a shareholder because the IRS does not recognize the employee as having received the restricted stock until the restriction lapses (that is, until the shares vest). Therefore, the IRC treats the payment of these dividends as compensation, and the entity is entitled to receive a deduction on the dividends paid. Likewise, dividends paid as part of a dividend-protection plan for option grants are treated as compensation for US tax purposes. ASC 718-740-45-8 states that the tax benefit from dividends, or dividend equivalents, that are charged to retained earnings and paid to employees for nonvested equity-classified restricted stock, restricted stock units, and outstanding options should be recognized in income tax expense in the income statement.