In many industries, equity-based compensation is increasingly common to attract, reward, and retain leadership, which are all essential for an organization’s success. While the specifics of compensation packages can vary between companies, a firm’s compensation philosophy should align with its overall business strategy and goals. A well-structured compensation package not only motivates executives to perform at their best but also fosters long-term commitment to the company’s success.

RSU, NQSO, ISO, ESPP – are financial acronyms you might come across during an onboarding process or when experiencing a promotion.  To ensure the decisions you make during this process align with your long-term financial goals, it is essential to understand what each means and its compensation benefits.

Employee Stock Purchase Plans (ESPP) give employees the right to purchase company stock, often through after-tax payroll deductions, at a discounted price. Most companies set a discount rate that is 10% to 15% below the current market value of the stock. Once ESPP shares have been purchased, you can sell them at your discretion. Typically, there are no tax consequences on the date of purchase. Taxes are only due when the ESPP shares are sold. Depending on when you sell your shares, the disposition will either be considered qualified or non-qualified, which impacts the tax that might be due.

Rachel has participated in her company’s ESPP program during the five years she’s worked at her firm, which offers a 15% discount with an offering period every six months. She would like to purchase her first home and wants to utilize some of the shares she purchased through the ESPP program for the down payment as the stock has gained value. If she sells her stock, the shares could either be considered a qualified disposition, which has a more favorable tax treatment, or a disqualifying disposition. A qualified disposition would be where Rachel holds the shares for more than two years from the grant of the shares and one year after she received them. If she were to sell her shares within two years of the offering period or within one year of receiving the stock, it is considered a disqualifying disposition. The main difference between a qualifying disposition and a disqualifying disposition relates to the amount of tax you may pay. Luckily, she has enough shares of stock she can sell in a qualifying disposition, recognizing the more favorable tax treatment, for the down payment on her home.

Restricted Stock Units (RSU) are a promise from your employer to grant you shares of company stock in the future, subject to certain vesting conditions. Once the RSU vest, you will then recognize compensation income based on the fair market value of the shares on the vesting date.

John, in his mid-thirties, owns his home, and makes the maximum annual contribution to his 401(k). He and his wife are now looking to start funding 529 plans for their young children. After being promoted a couple of years ago, he began receiving RSU as part of his compensation package. The current market value of the shares is similar to the price on the vesting dates. Since he already recognized ordinary income when the shares vested, selling them will result in minimal capital gains tax. He decides to sell some of his shares to help fund his children’s college education plans.

Non-Qualified Stock Options (NQSO) give you the right to buy a certain number of company shares at a specified price (known as the strike price) during a set window of time. Typically, your rights cannot be exercised until you have satisfied the vesting requirement set forth by the company. Once the NQSO vest, you can exercise your shares but are not required to do so. If you proceed with exercising your options, you will recognize compensation income based on the difference between the fair market value of the shares at the time you exercise the option and the strike price. Depending on how long you own the shares post-exercise, you may recognize either a short or long-term capital gain or loss at sale.

Jeremy was let go from his firm as part of an extended round of layoffs. As part of his compensation package, Jeremy has some vested Non-Qualified Stock Options (NQSO). These vested NQSOs must be exercised within 90 days of his departure. This period is known as the post-termination exercise period (PTEP). Tax rules generally require NQSO to be exercised within 90 days of departure to maintain their tax status, so most companies apply this 90 day window to all option grants for consistency. In cases of broader company layoffs, this period can sometimes be extended. Any unvested NQSO typically expire immediately upon termination. If Jeremy chooses not to exercise his vested options within the specified period, the options are usually forfeited and become void.

Incentive Stock Options (ISO) are like NQSO. ISO allows you to purchase a specific number of company shares for a set price at a later date. You will not recognize compensation income at exercise. Instead, depending on how long you hold on to the shares, you will either realize ordinary income or long-term capital gains.

Sarah is about to get married and go on her honeymoon. She has worked at her company for the past decade, during which she received Incentive Stock Options (ISO). When she got engaged a little over a year ago, she exercised 1,000 vested ISO in anticipation of using the funds to pay for her honeymoon. Since it has been more than one year since she exercised her options and more than two years since she received the grant, she will qualify for favorable tax treatment when she sells these shares and will pay long-term capital gains on the difference between the sale price of the shares and the exercise price from a year and a half ago. Additionally, she will need to check if the difference between the market price at exercise and the exercise price is subject to Alternative Minimum Tax.

Equity-based compensation plans are powerful tools for wealth accumulation and play a significant role in your financial strategy. However, they often come with diversification, liquidity, and tax challenges that necessitate careful management and planning. Managing these complexities is essential whether you’re aiming to build wealth or considering a transition that could involve forfeiting unvested equity compensation. Our team of professionals is dedicated to helping you navigate the complexities of your equity compensation, ensuring it seamlessly integrates into your overall financial plan. Through a comprehensive approach, our team empowers you to make informed decisions that support your long-term financial success.

Equity-based compensation plans are powerful tools for wealth accumulation and play a significant role in your financial strategy. However, they often come with diversification, liquidity, and tax challenges that necessitate careful management and planning. Managing these complexities is essential whether you’re aiming to build wealth or considering a transition that could involve forfeiting unvested equity compensation. Our team of professionals is dedicated to helping you navigate the complexities of your equity compensation, ensuring it seamlessly integrates into your overall financial plan. Through a comprehensive approach, our team empowers you to make informed decisions that support your long-term financial success.