You get a new job, and one of the many benefits bestowed upon you is equity compensation in the form of company stock. While equity compensation is a great way to boost your savings to help you achieve your goals and objectives, it requires special attention. There are several types of equity compensation that you can receive, and each type comes with its own set of terms and income tax characteristics. Companies typically do not have equity compensation specialists on staff to provide personal financial advice or guidance on how you should handle your grant. While they can guide you through the process and mechanics, they are not in the position to make personal financial planning recommendations. This comprehensive guide will help you navigate through equity compensation and hopefully help you understand the process and benefits of Equity Compensation.

Comprehensive Guide to Equity Compensation – Table of Contents

• Equity Compensation Part 1: Restricted Stock Awards (RSA) and Restricted Stock Units
• Equity Compensation Part 2: Employer Stock Options
• Equity Compensation Part 3: Employee Stock Purchase Plans
• 3 Things to Know When You Receive Equity Compensation
• Can You Expect to Receive Dividends on Your Equity Compensation?

Equity Compensation Part 1: Restricted Stock Awards (RSA) and Restricted Stock Units

With an increasing amount of companies offering equity compensation packages to their employees, it is essential for those receiving these benefits to understand the features of these different types of compensation. I would like to cover all of the popular forms of equity compensation, including:

• Restricted Stock Unit (RSU)
• Restricted Stock Award (RSA)
• Stock options
• Employee Stock Purchase Plan (ESPP)

A restricted stock unit (RSU) is a right to receive stock after you have satisfied certain conditions imposed by your employer. The most common condition is to remain employed with the company for a certain amount of time. But other conditions may exist. For example, your employer may impose a condition that is based on you reaching a certain sales goal or your team completing a project before the deadline. If these conditions are not satisfied, then you do not receive anything. It is important to remember that when it comes to restricted stock units, you do not own the shares until you have earned them – by satisfying the vesting period. This means that you will not receive dividends the company may pay before the date you meet the conditions.

Learn More In Part 1 of Our Equity Compensation Series

Equity Compensation Part 2: Employer Stock Options

An employee stock option is a right to purchase shares of company stock at a predetermined price. The two types of employee stock options are:

• Non-qualified stock options (NQSO)
• Incentive stock options (ISO)

While NQSOs and ISOs share similar mechanical features, they differ from an income tax perspective. The good news is that the employee does not have to report income upon granting options or when the options vest. However, when an employee chooses to exercise their options, they may have to register the revenue in the year of exercise. And this is where it gets tricky. If an employee exercises an NQSO, she will have the income to report. However, if she exercised an ISO, she would not have to register the revenue, but she may have to pay an alternative minimum tax (AMT). As you can see, many moving parts with the income tax associated with employee stock options exist. So let us now take at the tax characteristics of both NQSOs and ISOs.

When we compare the taxation of NQSOs to ISOs we will see that the rules are more complex. However, with this complexity comes the opportunity for employees to convert some or all of the profit (the spread) into a long-term capital gain, which is subject to a lower tax rate than ordinary income. Unfortunately, the IRS does not allow this tax benefit without a caveat – the alternative minimum tax (AMT). To take advantage of converting the spread as a capital gain, the employee must meet both of the following special holding periods:

• The stock must be held for one year after the date of exercise
• The stock must be held for more than two years after the option was granted

If the stock is sold before these requirements are met, the transaction will be considered a disqualifying event, in which case the spread is subject to ordinary income.

Learn More In Part 2 of Our Equity Compensation Series                                                  

Equity Compensation Part 3: Employee Stock Purchase Plans

With an increasing number of companies offering equity compensation packages to their employees, it is essential for those receiving these benefits to understand the features of these different types of compensation. In my previous articles, we discussed restricted stock awards (RSA), restricted stock units (RSU), and stock options, and this article will focus on employee stock purchase plans. 

An employee stock purchase plan provides a way for an employee to purchase shares of their company’s stock through payroll deduction. Not only is this a convenient way for an employee to buy stock, but the plan may allow the employee to purchase stock at a discount, which is not available for purchases made through the stock market. While the IRS has set a cap on the dollar amount ($25,000) of stock that an employee can purchase during the year, it is still a great way to become a shareholder in your company. Before we take a closer look at the mechanics and taxation of ESPPs, let’s first review the terminology associated with these types of plans.    

• Enrollment period (or grant date) – the period during which the employee can contribute to the ESPP via salary/bonus deferrals. 
• Purchase date – the date on which the company purchases the shares. 
• Lookback period – if there is a lookback period, then the company will purchase the shares either based on the value at the end of the enrollment period or at the end of the enrollment period, whichever is lower. 

Learn More In Part 3 of Our Equity Compensation Series   

3 Things to Know When You Receive Equity Compensation

• Type of award you received
  • Equity compensation comes in many forms; however, the most common types include restricted stock awards, restricted stock units, incentive stock options, non-qualified stock options, and employee stock purchase plans. Each of these types of plants operates differently, and each has its tax characteristics.
• Grant Date
  • The grant date is the date on which the award is approved by your company’s board of directors and granted to you. It is important to note that even though you have received a restricted stock or stock option grant, you will most likely not own the underlying shares or options as of the grant date.
• Vest Date
  • The vesting date is when you take ownership of all or a portion of your award. As mentioned above, equity grants are typically subject to a vesting schedule. This means that you receive requests for all or a part of the shares of stock or options over a while, as long as you stay employed with the company.

Can You Expect to Receive Dividends on Your Equity Compensation?

When an employee is granted RSUs, and since they are not considered a shareholder until they satisfy the vesting requirements, they will not receive any dividends during the vesting period. However, when the employee and those dividend payments receive the RSU shares vest, dividends will be considered dividend income and may be eligible for the preferential dividend income tax rates. Employees receiving an RSA grant are considered a shareholder as of the grant date. Therefore, as a shareholder, the employee will receive dividends that are paid during the vesting period. 

Contact Zynergy Retirement Planning Today

Equity compensation has become increasingly popular over the years. If you find yourself in a fortunate position where your company is providing you with equity compensation, you will want to ensure you know the type of equity you received along with the grant date and vest date. In addition, I would strongly suggest you reach out to our financial planners for a comprehensive look at how we can help achieve your goals and objectives.