Vested shares mean shares that you own, even if you're fired or you quit. They're a form of compensation. You most often hear about them as part of the reward for employees at hip startups, but that's not the only type of company that offers them. Vested shares can also be part of an overall compensation package at an established and publicly traded company or part of your retirement package.
As a form of compensation, vested shares are shares you own due to your time working in a company. You won't lose them if you leave the company.
Basics of Vesting
When you vest, it's not a choice of attire. Instead, it means you've served enough time in your company to gain the right to own its stock. You typically vest over a five-year period, though the time it takes to vest may vary according to the company and the reason for the award.
For example, if you receive an award of stock of 1,000 shares that vest over a five-year period, you may vest into 200 shares of stock on the first anniversary of the award. You can't do anything with the other 800 shares until you reach your second, third, fourth and fifth anniversary dates. On those dates, you vest into an additional 200 shares.
Vesting Schedules Demand Patience
Vesting into shares teaches you the value of waiting for a reward. While your cash compensation – salary, bonus and commission, perhaps – give you instant gratification, vesting takes time. A vesting schedule identifies how many shares you vest into each year, quarter or month. Some companies also further encourage you by accelerating vesting, if you make a certain deliverable date, for example. In addition, you may receive fully vested shares as an award for significant results.
Combined, you may have a variety of vesting schedules. Whip out a spreadsheet to stay on top of what you're vesting into and when.
Benefits of Offering Vesting
Offering vesting is a benefit to both you and your company. Your company doesn't have to pay out as much in cash compensation, because shares of stock represent ownership in the company and not an actual cash payment to employees, decreasing the drain on cash flow. As an employee, you receive the benefit of either a potential windfall from vesting into an option or the direct benefit of vesting into shares. In addition, vesting encourages employee retention -- few employees voluntarily walk away from the compensation potential that vested shares represent.
Taxes on Vested Shares
Since vested shares are a form of compensation, Uncle Sam needs his due. The manner in which you are taxed depends on the type of vested shares. If you're vesting into an option, you are taxed when you sell the stock. However, the taxes vary based on when you buy the stock and when you sell it.
When you vest into a stock award, you are taxed on the compensation income the shares represent. From the earlier example, you are taxed on the value of the 200 shares you vest into based on the stock price that day. If the stock is selling at $30, you are liable for $6,000 at your income tax rate. You may also be liable for further taxes if you later sell the stock.
For either type of vesting, you must report the sale of any shares and pay any related taxes when you file your income tax return using Form 1040 and Schedule D. Your tax adviser can best guide you in the proper reporting and tax implications.