Reader Kevin sent the following question on restricted stock units:
I work for a Canadian branch of a U.S. company. As incentives, we receive both stock option grants and restricted stock units. Since tax season is drawing near, I’m trying to gain a full understanding of the tax implications of both of these awards.
I believe that stock options are essentially taxed as capital gains. Say you were granted options with a strike of $50 and you exercise 500 when the FMV is $100. Your gain is 500*($100-$50) = $25000, and that gets taxed as normal income but there is also some sort of deduction of 50% that makes that gain essentially the same as if it had been a capital gain? So you really only end up paying tax on $25000/2 = $12500?
I found the above info in the fourth paragraph of the section Taxable Income – Employee Security Options Deduction available here.
I wasn’t able to find any information at all regarding Canadian tax treatment of restricted stock units. To continue the example above, let’s say that 200 RSUs have vested and I’d like to sell them when the FMV is $100. The cost is zero, so the gain would be 200*$100 = $20000. But is that taxed as ordinary income or is there anything in place to give RSUs the same preferential tax treatment as options?
Thanks for the question because I had to search for information on restricted stock. Employee stock options work exactly as you describe. Employees are given an option to purchase company stock at a certain price subject to a vesting schedule. A common example of a vesting schedule would be 1/4 of the options vest (i.e. can be sold) in the first year and 1/48th of the initial grant vests every month thereafter.
Restricted stock awards (RSA), also called incentive stock awards, are shares granted in your name as of the date of grant and held in escrow. The shares are called “restricted” because they are subjected to a vesting schedule similar to stock option grants. The shares will not be restricted upon vesting allowing you to sell the shares.
Canadian tax treatment of stock options is favourable as you describe. There are no taxes owed when stock options are granted and only 50% of the stock option profits are taxable when you exercise. RSAs, on the other hand, are taxed at grant in Canada, which makes them unpopular because employees have to pay ordinary income tax on money then don’t yet have.
Restricted Stock Units (RSU) provides similar benefits as RSA but instead of actual shares, employees receive an opportunity to receive stock in the future. This article suggests that RSUs are not taxed at grant and my understanding (based on this article) is that when RSUs vest and are converted into company stock, the value of the stock at the time of vesting will be considered as ordinary income and taxed at your marginal rate. If you are a tax expert or have experience with RSU, I’d love to hear your comments.