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I'm currently working at a startup and am going to receive some equity in the company through a restricted stock grant. The CEO inserted this clause into the grant agreement and it's giving me some pause because it wasn't in the original grant agreement drafted by the lawyers (actual dollar amounts replaced with (xxx) for privacy):

(iii) As of the Grant Date, the Administrator determined, and Participant agrees, that (1) the Fair Market Value of the Award is $(xxx) per share of Common Stock, or $(xxx) in total, (2) because the Award is deemed fully vested as of the Award Date, the Company is required to make a federal tax withholding payment of 22% of that amount, or $(xxx) in total (the “Withholding Amount”), (iii) to satisfy the Company’s withholding requirement, Participant must provide to the Company, upon the parties’ execution of this Grant Notice, a check for the Withholding Amount, made out to the Company, and (iv) provided that the Company deposits such check into its bank account within two business days after its receipt thereof, this Award shall be deemed null and void in the event that such check does not clear within five business days after the Company makes such deposit.

This doesn't seem normal given other agreements I've seen. Don't employees typically have the option to either pay cash or have the withholding taken out of the shares being granted?

If it matters, the company is located in Washington D.C. (where I live as well), is incorporated in Delaware, and is private and not going to IPO anytime soon.

Any advice will be greatly appreciated, thanks.

  • Something is a bit odd about that. Stock is essentially worthless until you sell it. It isn't income according to the IRS unless you are paid a dividend. Even if it's fully vested, it isn't income until you sell it. I've had fully vested stock in many companies, both start ups and public, and I've never had that. I'd ask your lawyer about that. – Ron Beyer Jul 2 at 3:52
  • @RonBeyer not sure if I agree fully, while dividends are taxed I believe that both restricted stock and RSU's are recognized as income and taxed at the time of vesting based on the difference between the amount paid and the value of the stock (unless you take the 83b election for restricted stock, in which case taxation occurs at the grant date). Since I'm not paying anything for this stock, I have to recognize all of it as income. What you might have experienced is the company withholding shares to satisfy the tax requirement, which seems more common and is the heart of my concern. – Thuy Guevarra Jul 2 at 5:05
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There's nothing strange about the language. The fair market value of vested shares of restricted stock is included in the employee's income as compensation. This is what is known as compensation "in kind" and it results in what is also known as "phantom income" - the employee (or, on occasion, contractor) has to pay tax in cash even though it received no cash to pay for it.

Since tax is owned even though no cash is received - the employer is required to withhold on this compensation at the 22% "supplemental wages" rate. Usually The employer is not going to go out of pocket for the employee: the employer can either get a check from the employee for that withholding amount or take it out from the employee's cash salary. It won't do that by taking back shares.

And, of course, this is just the withholding. When the employee files his tax return at the end of the year, he will have to include that fair market value as income and possibly pay more tax on it (depending on his effective tax rate).

The other alternatives (receive unvested shares or vested or unvested options) may avoid the phantom income problem but present totally different economic deals; so even if they are available, think carefully before switching.

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RSUs are taxable when they vest, so there is indeed tax due and it's reasonable for your employer to collect estimated income taxes. See https://www.schwab.com/public/eac/resources/articles/rsu_facts.html

It's a bit unusual for a private company to grant RSUs and let them vest before there is a way to turn the stock into cash. Typically private companies either do options or attach some "performance" condition to the vesting schedule to prevent any tax liability before the stock can be sold.

You are apparently in a bit of a pickle here: you have to pay tax on stocks that you can't sell for the foreseeable future. It may be worth talking with your employer about this.

  • Thanks for the response Hilmar, to clarify this is restricted stock not RSUs but I believe the tax treatment is the same in this case. When I read the grant agreement, the language makes it sound like I'm responsible for the tax withholding and must make arrangements satisfactory to the company to cover it before the "vested shares are released", however it also indicates that should I not make satisfactory arrangements the company can withhold shares (preferable to me) or withhold salary as a result. – Thuy Guevarra Jul 2 at 19:23
  • What's giving me pause is that they're insisting this clause be added to the grant agreement rather than relying on the already-existing language that came from the company's lawyer covering tax withholding obligations, which makes me think there's something fishy going on. – Thuy Guevarra Jul 2 at 19:24

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