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Underwater Options   
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Basics: Core Concepts

What advantages do restricted stock and RSUs have over stock options? How do the two grant types compare?

It's not easy to determine which type of grant is better for you. Restricted stock/RSUs always have some value to you, even if the stock price drops below the price on grant date. This may help you feel more of the wealth impact (and shareholder pain) of rises and falls in your stock price.

Example: Your company grants you 2,000 shares of restricted stock when the market price of its stock is $22. By the time the grant vests, the stock price has dropped to $20. The grant is then worth $40,000 to you before taxes. If instead your company grants stock options with an exercise price of $22, at vesting they have no real value, as the options are underwater by $2 when the stock price is $20.

Because restricted stock has full value at vesting, companies grant fewer shares of restricted stock than stock options (see the FAQ on the ratios of restricted stock and stock options). Although "underwater" options (market price lower than exercise price) have little practical value to you, options give you more leverage in a rising market than restricted stock does. On the other hand, if your company pays dividends, an advantage in restricted stock is that it may pay them on your restricted shares. (See a related FAQ on how you can calculate which grant is better in your situation.)

Alert: While the decision to exercise stock options lets you choose when you will pay taxes, with restricted stock you cannot control the timing of taxation in the same way. Therefore, it is important to understand the tax treatment and the withholding methods.
Restricted stock/RSUs Stock options
Value depends on the stock price at vesting, even if the price fell after grant. Value depends on any stock-price increase over the exercise price set at grant.
No payment needed to receive the shares. You pay the exercise price to buy the shares.
With restricted stock (not with RSUs), you have dividends and shareholder-voting rights during the vesting period. You get dividends and shareholder-voting rights only after you acquire the shares.
You own the shares upon vesting. You own the shares upon exercise.
The income is taxable at vesting, unless you filed a Section 83(b) election to be taxed on the value at grant (not available for RSUs). Option income is taxable at exercise for NQSOs and at share sale for ISOs.
For accounting purposes, the grant date "fair value" is spread over the vesting period, and forfeited unvested shares are not expensed. Accounting for performance shares depends on the goal(s) applied. For accounting purposes, the grant date "fair value" is spread over the vesting period. Underwater options are expensed, but forfeited unvested options are not.

To compare the taxation of various types of stock grants, see this related FAQ.

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