We at Boulay Financial Advisors often get questions about equity compensation that is offered by employers. In general, companies don’t do a great job of educating their employees on the different aspects of that compensation, how it is going to be taxed and how to manage them on an ongoing basis.
So what are the most common types of equity compensation? For most, they come in the form of either Stock Options or Restricted Stock Units. There are distinct differences between the two and variations within each broad category, so it is important to understand what you have.
First, let’s look at Stock Options. Stock options give you the right to buy a stock at certain price sometime in the future. As the stock goes above that strike price, that option becomes more valuable. If the stock price goes down below that strike price, the option becomes worthless. There is usually a vesting schedule associated with the options to encourage employees to stay with the company. There are two types of Stock Options, Incentive Stock Options and Non-Qualified Stock Options. These are tax differently so it’s important to know what you are offered.
This example below demonstrates an incentive stock option when the strike price is $15 at grant and you exercise when stock is at $20. Incentive Stock Options are not taxed when you exercise them, and as long as you hold them for at least two years after being granted and one year from when you exercise them, they get favorable tax treatment, as the proceeds are then taxed at long-term capital gain rates when sold. There can be some additional Alternative Minimum Tax considerations with Incentive Stock Options though, so it’s important to consult a tax professional on your individual situation.
This example below demonstrates a non-qualified stock option with the same parameters – strike price is $15 at grant and you exercise when stock is at $20. Non-Qualified Stock Options are taxed as ordinary income when exercised on the difference between the strike price and the fair market value of the stock. You can then hold the stock and pay the tax from cash, sell some of the stock to cover the tax, or sell all the shares after exercise and keep the cash after paying the tax due.
Restricted Stock Units are often confused with Stock Options but are very different. Restricted Stock Units are awarded and then vest either based on an employee’s time at the company or can be tied to pre-set performance targets. This example below demonstrates a Restricted Stock Unit when the stock price is $20 at vesting. Restricted Stock Units are taxed as ordinary income when they vest and there is no strike price that an employee has to pay to receive them, so the full value of the stock at vest is taxed as ordinary income. An employee can then pay the tax from cash and hold the shares, sell some of the shares to cover the tax and hold the remaining shares, or sell all the shares and pay the tax out of the proceeds.
So which equity compensation type is better? That depends on several factors such as the future stock price and your individual tax situation. Restricted Stock Units might be a little safer knowing that you don’t need the stock to go up to realize some value. Stock options can appreciate greatly if the stock does go up in the future so might have more upside.
Many companies offer employees a choice in how they receive their equity compensation, giving them the ability to choose between Stock Options and Restricted Stock Units. It’s important to know the differences and what might work better for your individual situation. If you need help with your equity compensation package a Boulay Financial Advisors professional would be happy to help you.
This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. Any tax advice contained herein is of a general nature. You should seek specific advice from your tax professional before pursuing any idea contemplated herein. This is meant to be a reference/guide, individual circumstances can influence outcome, verify planning with accounting and financial professionals.
This information provided has been derived from sources believed to be reliable, but is not guaranteed as to accuracy and does not purport to be complete analysis of the material discussed, nor does it constitute an offer or a solicitation of any offer to buy any securities, products or services mentioned. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. Consult your financial professional before making any investment decision.
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Investment Advisory Services offered through Boulay Financial Advisors, LLC a SEC Registered Investment Advisor. Certain Third Party Money Management offered through Valmark Advisers, Inc. a SEC Registered Investment Advisor. Securities offered through Valmark Securities, Inc. Member FINRA, SIPC
Boulay PLLP and Boulay Financial Advisors, LLC are separate entities from Valmark Securities, Inc. and Valmark Advisers, Inc. Prime Global is not affiliated with Valmark Securities, Inc. and Valmark Advisers, Inc.
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