Employee Stock Awards: What They Are and Their Impact on Income & Taxes

Equity or share-based compensation can be a powerful way for companies to incentivize employees to take ownership of the company’s performance and retain their loyalty. This can be a significant source of wealth for employees. Knowing and managing the value of your stock awards can make a big impact on your overall financial plan. Two of the key planning items to consider are managing the tax ramifications and mitigating risks that can arise.  

Below is a summary of the following common equity-based compensation plans: 

  • Restricted Stock Awards or Units (RSUs) 
  • Non-Qualified Stock Options (NQSOs) 
  • Employee Stock Purchase Plan (ESPP) 

Restricted Stock Awards (RSUs) 

Employers grant their employees a set number of shares of their stock. These are typically subject to a vesting schedule, most commonly over a period of 3-4 years. For example, a company may grant you 1,000 shares this year, to vest over the next 4 years. 250 shares would vest each year starting next year. To receive these shares, you must remain employed at your company during the vesting period. 

When you are awarded RSUs, you don’t have any immediate tax liability. However, when the RSU vests and you receive a payout of shares, 100% of the stock’s value at the time of vesting is counted as ordinary income in the year you receive it. Most companies will withhold taxes on the stock as it vests, so your net payout will be a lower number of shares than what was awarded. 

If you sell your vested restricted stock immediately upon vesting, no other taxes will be due. If you hold onto the stock and sell at a future date, any gain will be subject to capital gains tax rules. 

Employee Stock Purchase Plan (ESPP) 

ESPPs are programs in which employees can buy company stock, often at a discounted price. We most commonly see a discount of 10-15%.  

Employees typically take part in the program through payroll deductions. 

Taxation of ESPP shares can be complex and depends on whether the ESPP is qualified or non-qualified. (Non-qualified plans are subject to fewer restrictions, but do not have as many tax advantages for employees as qualified plans.) You are not taxed on the stock until you sell it. When you sell it, the income can be either ordinary or capital gain, or both, depending on if you meet the holding period and other requirements.  

Non-Qualified Stock Options (NQSOs) and ISOs 

NQSOs give employees the right, within a designated period of time (typically 10 years), to buy a set number of shares of their company’s stock at a pre-set price. The pre-set price is typically the same as the market value of the stock on the date the company awards the options to the employee (known as the exercise price). Employees will have a deadline to “exercise” or buy these options, known as the expiration date (typically 10 years). If the date passes without the options being exercised, the employee will lose the options. 

There is an expectation that the company’s share price will rise over time. That means employees can potentially buy stock at a discount if the exercise price that was originally awarded is lower than the future market price at the time of sale. An employee will effectively buy the stock (exercise their shares) at the original, lower fair market value, then receive the shares at their higher current market value. The employee can then either keep the shares or sell, effectively receiving the stock at a discount because of the growth of the share price. 

When you exercise non-qualified stock options, you must pay ordinary income taxes on the difference between the market price and the exercise price (original grant price). If you sell the stock immediately, no other taxes will be due. If you hold onto the stock and sell at a future date, any gain will be subject to capital gains tax rules. Given the complexity of this award type, it is important to have a long-term strategy.  

Nadine Thibault, CFP®, BFA™ | It is our mission to help you think differently about your wealth so you can LIVE WELLthy™ today and tomorrow.


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