Does the employee or employer decide how to satisfy the tax withholding requirement for restricted stock granted as income? [closed]

Question

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.

Answer 1

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.

Answer 2

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.