Restricted Stock: Vesting, Compensation Income, and Cost Basis

Restricted stock starts with something an RSU usually does not:

actual stock transferred to the service provider.

The stock may be subject to forfeiture or other vesting restrictions, but the employee already has property.

That puts restricted stock inside the Section 83 framework.

The default Section 83 rule

Under Section 83(a), property transferred in connection with services is generally included in income when it becomes transferable or is no longer subject to a substantial risk of forfeiture, whichever occurs first.

In a conventional vesting arrangement, that often means compensation is recognized as the shares substantially vest.

The amount is generally:

FMV at the taxable date − amount paid for the stock

Lapse restrictions are generally ignored when determining that value.

Example: restricted stock taxed at vesting

Suppose an employee pays $1,000 for restricted shares.

When the shares substantially vest, they are worth $10,000.

Compensation is generally:

$10,000 − $1,000 = $9,000

That $9,000 is compensation from services.

What happens to basis?

The compensation event also establishes the investment starting point.

Basis generally becomes:

amount paid + compensation recognized

Using the example:

$1,000 + $9,000 = $10,000 basis

If the employee later sells the shares for $15,000:

$15,000 − $10,000 = $5,000 capital gain

When does the holding period begin?

Under the default Section 83(a) regime, the capital-gain holding period generally begins after the stock becomes substantially vested.

That is important because the employee may have legally held restricted shares for months or years before the tax holding period begins.

An 83(b) election changes that timing.

What about dividends before vesting?

Payments made on substantially nonvested stock before the default Section 83 inclusion event can be treated as compensation rather than ordinary investment dividends under the applicable Section 83 rules.

The label used by the company does not by itself determine federal tax character.

Restricted stock versus an 83(b) election

The default treatment described above assumes no valid Section 83(b) election.

An eligible taxpayer can instead elect to include the value of substantially nonvested property at transfer.

That can move both the compensation event and holding-period start earlier.

It also creates forfeiture risk because the employee may pay tax based on value that is later lost.

See 83(b) Election: When It Applies and the 30-Day Deadline.

Restricted stock versus RSUs

The distinction is structural.

Restricted stock: actual property is transferred subject to restrictions.

RSU: generally a contractual right to receive property or cash later.

That difference changes:

• Section 83 timing;
• 83(b) eligibility;
• basis timing;
• holding-period timing.

Do not use the terms interchangeably.

Withholding

When restricted stock creates compensation, the amount can enter the wage and withholding system for an employee.

The withholding method does not determine the final tax liability.

See Equity Compensation Withholding: Why the Amount Withheld May Not Equal Your Tax.

Multi-state restricted stock

If the employee performs services in more than one jurisdiction while the award is earned, the compensation component can create state sourcing questions.

The later stock appreciation is analytically separate.

See Multi-State Equity Compensation: Which State Taxes RSUs, Options, and Stock Sales?

Common restricted-stock mistakes

Watch for:

• treating restricted stock like an RSU;
• assuming no tax can occur until the stock is sold;
• forgetting that the default compensation amount uses value when the stock becomes taxable under Section 83;
• failing to add compensation to basis;
• starting the capital holding period at transfer despite using default §83(a) treatment;
• ignoring prevesting distribution treatment;
• making an 83(b) decision without considering forfeiture risk.

Related pages

• 83(b) Election: When It Applies and the 30-Day Deadline — compare the election with default §83(a) treatment.
• RSUs: When They Are Taxed and What Happens When You Sell the Shares — distinguish actual restricted stock from a future right to stock.
• Equity Compensation Cost Basis: How Double Tax Reporting Happens — carry the compensation event into the stock basis.
• Multi-State Equity Compensation: Which State Taxes RSUs, Options, and Stock Sales? — analyze service compensation across states.