What is Restricted Stock?

A restricted stock is otherwise called a letter stock or section 1244 stock. It describes the amount of a company's shares that are not registered but issued to shareholders, executives and directors of the company. 

Stocks of this nature are restricted owing to the fact that they are yet to meet certain criteria for them to be registered and unrestricted. A restricted is not transferable, companies that issue stock of this nature do so following the guidelines of the Securities Exchange Commission (SEC).

 Restricted stock can be traded under the graded vesting schedule. Once restricted stocks have been certified and no longer restricted, they can be transferred.

How is Restricted Stock Used? 

Most companies use restricted stock for employee-compensation purposes, these stocks fully are vested to employees after they have fulfilled some obligations and met requirements which might include contributing significantly to the growth of the company and staying in the company for a number of years. 

Restricted stock gained popularity in the mid 2000s. They are also issued to affiliates and insiders during merger and acquisition processes. Restricted stocks are issued in this situation to prevent the merger or acquisition from being distorted by unruly sales or transfer of stocks by insiders and affiliates. When used for employee-compensation plan, a restricted stock is become transferable only when the employer vests it. Employees who do not meet the criteria can forfeit the stock.

Restricted Stock Units vs. Restricted Stock Awards

Restricted stocks have two categories or variations, these are;

• Restricted Stock Units (RSUs)

This is a variation of restricted stock made as a promise to an employee which is to be vested at a predetermined time in the future. An employer who promises an employee RSUs agrees to give the stocks at a later date. As at the time promised, RSUs are not stocks but only a promise to stock which can then be converted to stock at a future date.

• Restricted Stock Awards (RSAs).

A restricted stock award comes with voting rights, this quality distinguishes it from RSUs that carry no voting rights. RSAs are stocks given to employees to compensate them for their contribution to a company, these stocks are immediately awarded and come with voting rights.

Taxation of Restricted Stock

Section 1244 of the Internal Revenue Code (IRC) governs restricted stocks, which is why the are otherwise called section 1244 stock. Holders of restricted stock are required by the IRS to pay capital gains or loss on the stock. The taxation of this stock is determined by the difference in the stocks price at the date it was vested and the date it was sold. There are many tax options available to holders of restricted stock, these are all contained in the IRC.