Simplest isn’t always best, unfortunately.
Rick Segal writes about his preference for restricted shares over stock options, based on the fact that restricted stock is easier to explain than an option. That’s true. No need to worry about strike prices, exercise dates, and all that stuff.
The tax consequences of restricted shares, though, are substantially different.
If you’re an American, restricted shares are either taxable when they vest, or taxable at the time they grant. Here’s a nice web page from Fidelity explaining this.  Stock options are taxable when they’re exercised. You get the picture? When you work for a startup who gives you a grant of restricted stock, the first thing you do is get your check book out and write a check to the IRS. You can either elect to pay all the tax at the time that the restricted stock is granted, or you can elect to pay tax on the fair market value as the stock grant vests. Which is worse? It’s tough to say. If your company tanks, and you’ve paid the tax to Uncle Sam, then you have a capital loss on paper. If your company soars, and you elect to pay tax as the stock vests, your grant becomes more and more expensive — your tax bill becomes higher and higher, even though you may not want to sell the stock right away. Stock options, by comparison, are only taxable at the time they’re exercised. No tax is owing until you decide to take your gain.
There is an upside to restricted stock. If you own restricted stock for long enough, the gains will be taxed at the long term capital gains rate, which is half the rate that stock options are taxed. Restricted stock can be a good thing for you in the long run. But be ready to write your check to Uncle Sam to get that benefit.
In Canada, restricted stock is taxed as ordinary income at the time of the grant. Get $50,000 of stock, pay Revenue Canada it’s share.  The catch is this – if the vesting conditions aren’t satisfied, you don’t get to claim the tax back. There is one potential upside. Unlike a stock option, if your company pays a dividend (an unlikely event for a startup) you get to participate if you own restricted stock.
By comparison, if you are a Canadian resident and own stock options in a Canadian company, the tax treatment is very favourable. The option is taxed, not at the time it is exercised, but rather at the time when the underlying stock is sold. And, it’s always taxed at the capital gain rate, which is half the rate of ordinary income. In Canada, a stock option has all the tax benefits of restricted stock in the US, but without any of the negatives.
As Rick points out, restricted stock granted at a penny a share, or stock options granted with a penny exercise price are basically the same. And, in the case of a very early stage startup, it’s likely easier to give out restricted stock. But as soon as the valuation moves up, new grants of restricted stock become a tax liability for the employee.
There you have it. Restricted stock is easy to understand, but I’d always take options if they were offered.
My lawyer made me say this:
Not intended as legal advice. Please consult a tax specialist before making any important decision with tax consequences.
