Many companies pay out part of their profits to shareholders as a dividend. While dividends typically consist of cash distribution, there are times when a company may decide to issue a stock dividend. When it comes to dividends and your equity compensation, it is essential to understand the type of equity compensation you received (e.g., restricted stock units, restricted stock awards, stock options) because this will help determine not only if you’re eligible to receive dividends, but also how those dividends will be treated for income tax purposes. I will limit this discussion to restricted stock units (RSUs) and restricted stock awards (RSAs); as an employee who owns stock options, you will not receive dividends until you exercise the option and become a shareholder.
Before we dive into whether you receive dividends on the shares of stock granted as part of an equity compensation package (Part 1), a quick review of RSUs and RSAs is in order. When an employee is granted RSUs:
- Employees do not own the shares outright on the grant date.
- Employees must satisfy a vesting period before they are considered the owner.
- RSUs represent a future promise made by your employer.
- Shares are only issued to the employee after a vesting period.
Unlike RSUs, when an employee is granted RSAs, the stakes are given to them on the grant date. In other words, the employee will own the shares as of the grant date. However, it is important to note that even though they own the shares, these shares are held in an escrow account until the employee satisfies the vesting period.
Dividends & Equity Compensation
Regarding dividends and equity compensation(Part 2), the keyword is shareholder, as only shareholders are eligible to receive dividends. When an employee is granted RSUs, and since they are not considered a shareholder until they satisfy the vesting requirements, they will not receive any dividends during the vesting period. However, when the employee and those dividend payments receive the RSU shares vest, dividends will be considered dividend income and may be eligible for the preferential dividend income tax rates.
On the other hand, when an employee receives a grant of RSAs, they are considered a shareholder as of the grant date. Therefore, as a shareholder, the employee will receive dividends that are paid during the vesting period. However, for tax purposes, the IRS treats the employee as if they do not own the stock yet. Any dividend income received during the vesting period will be considered compensation income, and dividends will be reported on the employee’s W-2. This means they will not qualify for the lower tax rates that apply to most dividend income. However, any dividends received after the vesting period qualify for the preferential dividend tax rates. (Part 3)
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If you find yourself in a fortunate position where your company is providing you with equity compensation, you will want to ensure you know the type of equity you received along with the grant date and vest date. In addition, I would strongly suggest you reach out to your financial planner to get a comprehensive look at how your equity compensation can help you achieve your goals and objectives.