Dividends and Equivalents: Ten Things to Know

When companies pay dividends on their common stock, the dividends contribute to the value of the stock. Because of this, most companies that grant full value awards to their employees also pay dividends or equivalents on the awards. If the awards are not eligible for these payments, the awards won’t fully track the value of the underlying stock; every dividend payment will further devalue the awards.

Here are ten things to understand about how dividends are paid on equity awards.

Dividends vs. Equivalents

Items 1 to 3 on our list explain fundamental concepts on how dividends can be paid on equity awards.

1. Restricted Stock Typically Earns Dividends

Because the shares underlying restricted stock are issued at grant, restricted stock awards are generally eligible for dividends paid after the grant date, even if the award hasn’t vested yet.  

This isn’t a legal requirement. It is possible for companies to structure restricted stock awards so that they are ineligible for dividends, but it is rare for companies to do this.

2. RSUs Can’t Earn Dividends Prior to Settlement

The shares underlying restricted stock units aren’t issued until the awards are settled. RSUs are simply a promise that the company will issue stock to the award holder in the future, after the vesting conditions have been achieved.

Because holders of RSUs don’t yet own the stock underlying their awards, they aren’t able to participate in the dividends paid to common stockholders.  But once the vesting conditions have been met and the awards are settled, the award holders will also be stockholders (assuming they don’t immediately sell the stock acquired upon settlement of the awards). As stockholders, they will be able to participate in any future dividends paid on the stock.

3. RSUs Can Earn Dividend Equivalents

RSUs are intended to track the value of a company’s common stock. As I noted above, the dividend payments contribute to that value. For this reason, companies that grant RSUs often pay “dividend equivalents” on the awards.

Dividend equivalents are exactly what they sound like: a payment to the award holder that is the equivalent of the dividends paid on the common stock underlying the award. These payments provide RSU holders with the same benefit that a shareholder would receive.

Dividend equivalents are sometimes referred to as dividend equivalent rights (DERs) or dividend equivalent units (DEUs).

Design of Dividend Programs for Awards

Items 4 to 7 on our list highlight important design considerations for your award dividend program.

4. Dividends and Equivalents Can Be Paid Currently or Deferred

Both dividends and dividend equivalents can be paid on a current or deferred basis. Payment on a current basis means that the dividend or equivalent is paid to the award holder at the same time dividends are paid to shareholders, which may be before the underlying award vests. Paying dividends/equivalents in this manner can have accounting consequences for the company if the underlying awards are subsequently forfeited.

Dividends and equivalents paid on a deferred basis are accrued on the award when dividends are paid to shareholders but aren’t paid out to the award holder until vest/settlement of the underlying award. When paid on a deferred basis, dividends and equivalents are subject to the same vesting conditions as the underlying award; if participants forfeit their awards, they also forfeit the dividends or equivalents accrued on them.

5. Dividends and Equivalents Can Be Paid in Cash or Stock

Dividends and equivalents can be paid in cash or reinvested in additional stock or units. Dividends/equivalents paid on a current basis are most often paid in cash. Dividends/equivalents paid on a deferred basis are often paid in stock or units.

When paid in stock, the cash value of the dividend/equivalent is divided by the current FMV of the underlying stock to calculate the number of shares or units the award holder is entitled to. This is different than a stock dividend, which is more like a stock split.

6. Dividends/Equivalents Paid on Performance Awards Should Be Subject to Forfeiture

When performance-based awards are eligible for dividends prior to vesting, the dividend payments should be subject to the same performance conditions as the underlying award. If an employee forfeits any portion of a performance award, a commensurate portion of the dividends accrued on the award should also be forfeited. If an appropriate adjustment is not made, the company will be forced to recognize an accounting expense for the dividends.

7. Some Companies Don’t Pay Dividends/Equivalents on Awards

Companies are most likely to pay dividends on restricted stock (98% of companies that grant restricted stock pay dividends on the awards) and are least likely to pay dividends on performance-based awards that are settled in cash (only 31% pay dividend equivalents on these awards).

Regulatory Considerations

Lastly, items 8 to 10 on our list cover some regulatory pitfalls to be watch out for.

8. Dividends and Equivalents Can Have Global Implications

If dividend/equivalent-eligible awards are granted to participants located outside the United States, it is important to understand any specific regulations that might apply to these employees. In some locations, paying dividends before awards vest could alter the tax treatment that applies to the awards because employees will have already realized a benefit on the awards. Be sure to consult with your global advisors before making any decisions on dividends or equivalents for non-US locations.

9. Taxation of Dividends Paid on Restricted Stock Varies

The tax treatment of dividends paid on restricted stock depends on whether the award holder filed a Section 83(b) election. If the award holder did not file a Section 83(b) election (the most common scenario), the dividends are treated as taxable wages for both federal income tax and FICA purposes when they are paid to the award holder. If the award holder is an employee, the dividends are subject to tax withholding and must be reported as wages on the employee’s Form W-2.

If the award holder filed a Section 83(b) election for the award, dividends paid on the award are generally treated as dividend income, which is not subject to tax withholding and is reportable on Form 1099-DIV. (Note that there is some uncertainty around this treatment when dividend payments are deferred until vest.)

10. Dividend Equivalents Paid on Units Are Taxable Wages

Dividend equivalents paid on restricted stock units are treated as wages subject to federal income tax when paid to the employee. Dividend equivalents are typically paid out on a deferred basis (i.e., only when the underlying award is paid out). In this case, the dividend equivalents are subject to federal income tax when they are paid out, along with the shares underlying the award. When dividend equivalents are paid on a current basis, they are subject to federal income tax at the time of the payment.

Dividend equivalents are usually subject to FICA at the same time they are subject to federal income tax, but the FICA treatment can differ for RSUs that are subject to deferred payout or payout on or after retirement.

Learn More

Learn more about dividends and equivalents in our comprehensive NASPP guide “Dividends and Equivalents Paid on Equity Awards.” This article covers the above topics in more detail, clarifies what the ex-date is (and other key concepts), explains the accounting treatment of dividends and equivalents, and highlights trends in how dividends and equivalents are paid on equity awards.