Understanding Your Stock Plan

March 8, 2021

As part of your equity compensation, a company may offer different plans. Here, we break down each type of plan and their rules.

Restricted Stock Units (RSU)

Restricted stock units are a type of equity compensation plan where employees are awarded stock in their company over a certain period of time, usually four to five years, if they remain at the company.

There are three important dates in the timeline of a RSU grant:

  • Grant Date: The initial date when the RSU plan is created. The number of shares that will be transferred over at certain points in time is specified.
  • Vest Date: There are multiple vest dates over the life of the plan, at which points a portion of the total stock granted is transferred to the recipient. See your RSUs vesting schedule to see when you gain ownership of shares. Until they vest, granted shares are only an unfulfilled commitment. Each vesting date is important because the value of the stock is subject to taxable income every time there is a vesting.
  • Sell Date: Depending on the terms of the plan, you may have to hold the stock for a certain period of time before you are allowed to sell them. Also, you must hold the stock for at least one year to be taxed at a favorable long-term capital gains tax rate. If not, they get taxed as short-term capital gains, which means your ordinary income tax rate.

Since vesting usually results in a large chunk of taxable income, it is common for company plans to surrender a portion of shares that vest to pay for taxes at each vest date. Also, it may be written in the grant rules that certain events such as an acquisition, or IPO will trigger immediate vesting of shares in the plan.

Whatever your situation is, RSUs have the most significant tax implications out of any other stock plans. In order to maximize your funds, it is important to project your income and tax brackets in future years to calculate what you will owe and plan for how you will pay for it.

Stock Options

Generally, stock options give the owner the right to buy a certain amount of stock at a predetermined price (strike price) that is usually the fair market value of the stock at the time they are granted. If the share price of your company increases and you have been granted stock options, the benefit is that you get to purchase shares at a lower price. There are two types of stock option plans that may be offered to an employee: incentive stock options (ISO) and non-qualified stock options (NQSO).

When ISOs are issued, known as the grant date, the employee has the right to exercise the right to purchase the stock. They always expire 10 years from the grant date, at which point the employee must exercise their options or forfeit them. Typically, there is a vesting schedule that must be satisfied before the employee can even exercise the options and is usually a three-year cliff schedule. The advantage of ISOs over NQSOs is that your proceeds may be taxed at long-term capital gains rates, rather than ordinary income tax rates. If the stock is held at least one year from the date of purchase (date exercised) and two years from the date it was granted, it qualifies for this tax treatment.

NQSOs are different because the proceeds from their exercise are included in your W-2 and are subject to both payroll and ordinary income taxes. Also, stock is subject to capital gains taxes when they are finally sold. These options typically have an expiration date and are subject to a vesting schedule.

For both of these options, there may be certain conditions under which the company may reclaim them such as bankruptcy, acquisition, or if you leave the company.

Employee Stock Purchase Plan (ESPP)

An ESPP gives employees of a company the right to buy their stock at a discounted price, using funds from payroll deductions. The discount is usually 15% lower than the market value of the stock price on either the grant date, or the purchase date. Usually, whichever price is lower.

When the ESPP is initiated, the offering period begins, and employees submit the amount to be deducted from their pay to contribute towards purchasing stock. Payroll deductions begin on the grant date until the first purchase date. Each purchase date uses your accumulated contributions to purchase stock at the discounted price, and then a new payroll deduction period begins.

There are both qualified and non-qualified ESPPs. Qualified plans only tax the amount of the discount as ordinary income. The remaining gains get taxed at long term capital gains rates. Also, the offering period of a qualified plan cannot be greater than three years. Non-qualified plans may result in the entire gain being taxed as ordinary income.

Timing Is Everything

If you are a participant in any of these plans, it is important to understand that the dates of grant, vesting, purchase, and sale, all affect your taxes and overall financial plan. In addition, other events such as when you joined or left the company, an acquisition, or IPO, can change how much you benefit as well. Equity compensation is often a large portion of an employee’s net worth, so it is valuable to have a financial plan that takes into account the timeline of stock plan.