In addition to providing you with a pay check, some employers choose to sweeten the relationship by providing stock in the company. It may come in one of two forms: Restricted Stock Units (RSUs) or Stock Options.
What Is an RSU?
Restricted stock units (RSU) are a simplified version of stock options (which will be covered shortly). The company commits to giving you stock or cash once you meet certain requirements like performance goals or a length of employment time. “Upon vesting, they are considered income, and a portion of the shares is withheld to pay income taxes. The employee receives the remaining shares and can sell them at their discretion”(Kagan, 2020). The value is based on what the stock is currently worth. You will want to check with your benefits department to determine if it’s the company or you who determines if you get actual stock or cash, as this choice ultimately is left up to the company.
What Is a Stock Option?
A stock option lets you purchase equity/stock in the company at a determined price (which may be a reduced price to the current market or FMV). You will have a certain window of time to make the purchase. You are not required to buy, it’s up to you. There is usually a vesting schedule like maybe a year before you can buy the stock option.
There are vesting schedules, option equivalency (example: one stock option equals 100 shares), and exercise dates when you are no longer able to exercise your right to stock options which may apply, so again you’ll want to check with your benefits department to see what is company policy.
Here is where it gets even more confusing, Stock Options come in two sub forms: NSO (non qualified stock options) and ISO (Incentive stock options). You need to be sure you understand which is offered, so ask your benefits department. Both ISOs and NSOs are a right to purchase at a stated price. You’ll want to determine if you believe the value of the market price of the stock will be greater down the road.
Taxation is key regarding NSOs and ISOs
- ISOs – You only report income at the sales of an ISO not at grant or exercise. ISOs provide favorable taxation at LTCG rates, but they come with max dollar restrictions of $100,000 which allow them to remain ISOs. If the value of an ISO exceeds $100,000 the remaining ISOs become NSOs.
- NSOs – Taxed at either STCG (short term capital gains – held less than a year) or LTCG (long term – longer than one year) depending on the holding period (Hwang, 2020).
Which is best?
RSUs have gained popularity as they represent pure gain since you don’t have to pay outright to obtain them. Whereas stock options are actually purchased which may lead you to feel they will only be of value if the market price goes up after grant. No right or wrong answer here, it really depends on factors like your long term thoughts about the value of the company and any tax considerations you may have.
Terminology and Key Concepts:
Strike Price, is the cost of your option contract. Example, you can buy 100 shares at $20/share.
Grant date is when option is made available to you (when you and your employer agree on terms), it’s the same for RSUs and Stock Options. If the strike price is equal to or greater than FMV of the underlying stock, there is NO Tax implication for either RSU or Stock Options at this time. Usually this is the case.
Vesting date like Grant date, there is NO Tax implication for either RSU or SO if the strike price is at least equal to FMV
Exercise Price you pay at Grant, there is no price you pay for RSUs, you are not laying out any cash, but for Stock Options you are paying cash (usually a reduced price) for the stock.
Spread/bargain, the difference between price at grant and exercise. Example, Grant strike price is $20 and at exercise it’s $100, the spread = $80.
Holding Periods, ISO 1 year from grant to ex and 2 years from grant to sale provides LTCG taxation. ***If grant and sale occur in the same year, ISO is unfavorably treated like NSO for tax.
Holding Periods, NSO either STCG or LTCG depending on if it was held 1 year.
AMT (Alternative minimum Tax), is a tax above your normal tax targeting high earners. You can mitigate exposure to AMT by lowering your earned income done by contributing to your 401(k). Since you are under age 50, your 2021 max 401(k) contribution = $19,500. Also, you may or may not have unused AMT credits from previous years, so you should consult with your CPA (Lake, 2018).
***Important *** TAX
ISO, the spread is taxable for AMT purposes, but not regular income or employment tax (SS and Medicare). You will want to consult with your tax pro to see if this applies to you.
NSO Stock Options, the spread is taxable as ordinary income and employment tax, but not subject to AMT.
Some companies offer employees Restricted stock units (RSU’s) or Stock Options as a form of employee compensation without having to lay out cash. This has potential for being beneficial for both the employee as well as the employer. RSU’s have gained in popularity as they do not require the employee to pay cash for this option like their stock option counterparts. Understand the difference between RSU’s and Stock Options as their taxation strategies vary significantly.
About the Author
Author, Marianne Martini Nolte, Certified Financial Planner ™ practitioner, provides fee-only, fiduciary, independent financial services. IMAGINE FINANCIAL SERVICES (IFS) is a registered investment advisor offering advisory services in the State of California and in other jurisdictions where exempted. Marianne’s focus is serving women and generations X, Y, and Z.
This article is intended as a high level view. All written content is for information purposes only. Opinions expressed herein are solely those of IFS, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to other parties’ informational accuracy or completeness.
For more in depth information, please reach out:
Marianne Martini Nolte, CFP®
Imagine Financial Services
Phone, (760) 472-5155
Hwang, A. (2020, July 23). Differences Between Incentive Stock Options and Nonqualified Stock Options: Davis Wright Tremaine. Retrieved January 07, 2021, from https://www.dwt.com/blogs/startup-law-blog/2020/07/differences-between-iso-nso
Kagan, J. (2020, October 26). Restricted Stock Unit (RSU). Retrieved January 07, 2021, from https://www.investopedia.com/terms/r/restricted-stock-unit.asp
Lake, R. (2018, February 28). Will You Owe the Alternative Minimum Tax? Retrieved January 07, 2021, from https://smartasset.com/taxes/will-you-owe-the-alternative-minimum-tax