Many companies use equity compensation as part of their employee compensation packages. Three common forms of equity compensation are incentive stock options (ISOs), non-qualified stock options (NQSOs), and restricted stock units (RSUs). While all three offer the potential for financial gain if the company’s stock increases in value, there are important differences between them that employees should understand.
Incentive Stock Options (ISOs)
ISOs allow employees to buy company stock at a discounted price (the grant or strike price). Employees only owe taxes on the difference between the grant price and the market price when they exercise the options. Further, if they hold the stock for at least one year after exercising the option and two years after the grant date, they pay capital gains tax rates on the difference instead of regular income tax rates. ISOs provide the most tax advantages but are subject to several limitations, such as a $100,000 limit on the value of shares that can vest annually.
Non-Qualified Stock Options (NQSOs)
NQSOs also allow employees to buy company stock at a discounted price. However, employees owe taxes on the difference between the grant price and market price at both exercise and sale. This difference is taxed at ordinary income tax rates. NQSOs do not have the holding period requirements of ISOs and have higher limits on the number of options that may be granted.
Restricted Stock Units (RSUs)
RSUs represent the right to receive full shares of company stock after a vesting period. Employees do not purchase stock. Unlike options, taxes on RSUs are not owed until the shares are actually received. Once vested, the entire value of the shares (at current market prices) is taxed as ordinary income.
In summary, ISOs can provide the most tax savings but are limited in amount. NQSOs provide more flexibility for companies in the number of options granted, but have less favorable tax treatment. RSUs allow employees to receive full shares without an upfront purchase but result in higher taxable income when received.
For additional information on ISOs, NQSOs and RSUs and the financial impact they may have, please contact us at (972) 960-1001 or complete a website request here.
__
Disclaimer
The information contained in this article is provided for educational purposes only. Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by LFC), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from LFC. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. LFC is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the LFC’s current written disclosure statement discussing our advisory services and fees is available upon request. If you are an LFC client, please remember to contact LFC, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services.