Stock Compensation
Frequently Asked Questions
What are Restricted Stock Units (RSUs)?
Restricted Stock Units (RSUs) are company shares granted to you that vest over time. Once vested, they are treated as ordinary income based on the market value of the shares on the vesting date.
Similar to a cash bonus but paid in shares of company stock.
How are RSUs taxed?
Single trigger RSUs(most common) are taxed as ordinary income when they vest. (Different rules can apply for private companies that don’t have the same ability to liquidate shares when they vest)
- The value on the vesting date is added to your W-2 income (regardless of whether you keep or sell the shares
- Federal withholding is 22% if income is less than $1 million or 37% if > than $1 million. This commonly leads to under withholding for high income earners below the $1 million threshold.
- State taxes apply.
- If you sell later, capital gains taxes or losses apply on the difference between the price at vesting and the price you sell.
Common Issue I See:
Notify your tax preparer when you sell vested RSU shares. Cost basis often needs to be adjusted based on your 1099b supplemental information. If a needed adjustment is missed this will cause you to over report your gain and pay more taxes than necessary.
Should I sell or keep my RSUs immediately after they vest?
Key questions to consider:
- Do you need to sell any shares to cover the tax liability from shares vesting?
- What percentage of your net worth does the stock represent?
- Are you aware of how the concentration impacts your ability to reach your financial goals?
- Do you have other needs for the funds? (i.e. home renovations, kids’ educational costs etc)
- Would you buy the stock if you received a cash bonus instead of shares?
For many professionals nearing financial independence, reducing concentration risk with taxes in mind, is a priority.
What is an Employee Stock Purchase Plan (ESPP)?
An ESPP allows you to purchase company shares at a discount, through payroll deductions over a set period of time.
Many plans also include a “lookback” feature, which can significantly increase the effective discount.
For example, you elect an amount to have deducted from each paycheck, at the end of the 6-month period they use the accumulated funds to purchase the stock 15% below the lowest share price during that 6-month window. If the lowest price was $100 but the stock was currently trading at $115 a share, you would purchase the shares for $85 a share. Leading to quite the profit.
How are ESPP shares taxed?
Timeframe determines how shares are taxed.
There are two types of sales:
Qualified disposition: To qualify you must hold the shares:
- At least 2 years from the offering date (beginning of 6-month purchase window in our example)
- At least 1 year from the purchase date
You must satisfy both rules, otherwise it becomes a
- Disqualified disposition
The tax treatment for a disqualified disposition results in owing ordinary income on the entire gain. So $30 a share in our example.
For a Qualifed disposition
Ordinary income = the lesser of:
- The discount based on the offering date price
OR - The actual gain
Discount based on offering price:
Let’s assume the shares increase from $115 at time of purchase to $125 a year later.
The lesser amount is $15.
So:
- $15/share taxed as ordinary income
- Remaining $25/share taxed as long-term capital gains
Planning Note:
Time provides the potential for better tax treatment, but shares do not always go up after vesting. Some investors choose to sell early, willingly paying the higher ordinary income tax to avoid a potential loss while waiting for long term capital gains treatment.
What are Incentive Stock Options (ISOs)?
Incentive Stock Options can be a valuable part of your compensation package.
Why ISOs can be attractive:
- You control when or if you exercise your stock options.
- Incentive Stock Options offer the potential to participate in stock price appreciation.
- Incentive Stock Options are not subject to payroll taxes.
- Incentive Stock Options can qualify for long-term capital gains.
They can offer favorable tax treatment but they come with complexity, especially related to the Alternative Minimum Tax (AMT). learn more
How are ISOs taxed?
ISOs are unique:
- No ordinary income tax at exercise (if held).
- But the “spread” between strike price and market value at excercise may trigger AMT.
- AMT paid in one tax year may be applied back as a credit in a future tax year
- If held long enough after exercise (1 year) and grant date (2 years), gains qualify for long-term capital gains treatment.
Tension: Exercising sooner, often lowers your tax bill compared to waiting, but carries risk that the stock drops after exercising.
What are Non-Qualified Stock Options (NSOs)?
Non-Qualified Stock Options (NSOs) give you the right to purchase company shares at a fixed “strike” price. If the stock price rises above that price, you can exercise the option and benefit from the appreciation.
How Are NSOs Taxed?
Unlike Incentive Stock Options (ISOs):
- The difference between the stock’s fair market value and the strike price at exercise (the “spread”) is taxed as ordinary income.
- If you hold the shares after exercising, any additional appreciation is taxed as capital gains when sold.
When Are Options Treated as NSOs Instead of ISOs?
Stock options may be issued as NSOs from the start. ISOs can also be treated as NSOs in certain situations:
- If more than $100,000 worth of options become exercisable in a calendar year, only the first $100,000 (based on fair market value at grant) qualifies as ISOs. Any excess is treated as NSOs.
- If ISO shares are sold before meeting the required holding periods (a “disqualifying disposition”), they lose their preferential tax treatment and are taxed similarly to NSOs.
What are Stock Appreciation Rights (SARs)?
Stock Appreciation Rights (SARs) are a form of equity compensation that allow you to receive the increase in company stock value over a set period without purchasing shares.
SARs are granted as part of a compensation package and typically include a grant date, exercise price, vesting schedule, and expiration date.
The grant of SARs is not a taxable event.
When exercised:
- You receive the difference between the stock’s market price at exercise and the exercise price, multiplied by the number of SARs exercised.
- That amount is taxed as ordinary income and subject to payroll taxes.
- SARs are often (but not always) paid in cash.
- No upfront purchase is required.
SARs are often used as an alternative to stock options because they provide upside participation without requiring capital to exercise.
What are Performance Share Units or Performance Awards?
Performance Share Units (PSUs) are a form of equity compensation that grant company shares based on the achievement of specific performance goals.
Unlike RSUs, which typically vest based only on time, PSUs vest only if certain company or individual performance targets are met. These targets often relate to metrics such as revenue growth, earnings per share, return on equity, or total shareholder return.
PSUs are granted with:
- A grant date
- A defined performance period (often 1–3 years)
- Specific performance metrics
- A vesting schedule tied to results
The grant of PSUs is not a taxable event.
When PSUs vest:
- The value of the shares received is taxed as ordinary income.
- Payroll taxes apply.
- If shares are held after vesting, any future appreciation is taxed as capital gains when sold.
Because payout depends on performance results, the number of shares ultimately received may be higher or lower than the original target grant.