Equity Compensation Overview
An increasing number of companies, especially those in certain industries such as tech, offer some form(s) of equity compensation to align employees’ financial interests with company goals. This is most common with publicly traded companies, though some private companies offer stock incentive plans as well. This guide provides you with a high-level overview of the four most common types of equity compensation.
Restricted Stock Units (RSUs)
RSUs are company stock granted to employees, but not available until a future vest date. RSUs are treated as having a $0 set purchase price, or strike price, so when it vests, the stock is received at that time at no cost.
Clients owe income and payroll tax at the time of vesting on the full value of RSUs. From there, the shares are treated exactly the same as if they had been purchased on the open market, with any change in value taxed as a capital gain or loss at the time of sale.
Employee Stock Purchase Plans (ESPPs)
These programs let employees purchase company stock at a discounted price using contributions they make through payroll deductions. The discounted stock price is typically 5% – 15% lower than market price.
Taxes are due at the time of sale with the discount component taxed as ordinary income. Any gain above this amount may be taxed as either ordinary income or capital gains, depending on the holding period for shares.
Incentive Stock Options (ISOs)
An Incentive Stock Option gives an employee the right to buy stock shares at a strike price for a period of time, potentially buying shares at a discount if the share price rises above the strike price.
In addition, ISOs also offer potential income tax advantages, as income and payroll taxes are not owed at exercise. ISOs can instead qualify for long-term capital gains treatment at the time of the sale of the stock, if certain holding period requirements are met. However, the potential advantages can disappear and the tax implications can become complex as the bargain element (difference between the strike price and market price at exercise) can count as AMT income at the time of exercise.
Non-Qualified Stock Options (NSOs)
Like ISOs, Non-Qualified Stock Options give employees the right to buy shares of company stock at a preset price during a certain period of time.
The tax treatment of NSOs differs from that of ISOs and is simpler; however, clients must pay income and payroll taxes on the difference between the market price and the price they pay for the shares at exercise.
Whether clients should exercise and/or sell their company stock will depend on a host of factors, including their tax profile, cash-flow needs, view of the stock long-term, company trading policy, and broader investment portfolio.
Vicus Capital is neither a law firm nor a certified public accounting firm and no portion of the content should be construed as offering or disseminating specific legal or accounting/tax advice.
For Use with the General Public. Financial Planning and Advisory Services offered through Vicus Capital, Inc., a federally Registered Investment Advisor.
