Your Guide to Employer Stock Plans (and their tax implications!)

by | Mar 7, 2022 | Taxes

One of the questions we hear frequently from new clients is, what do I do with all this employer stock? 

 It’s a valid question. Employer stock plans come with complicated tax implications, earnings structures, and lots of extra rules. Below, I’ll explain the two main types of employer stock options plus another common type of equity compensation— restricted stock units. However, it’s always helpful to consider your specific situation with an advisor. 

What are employee stock options (ESOs)?

With this type of equity compensation, employees are given the right to buy shares of stock in their company for a specific price during a specific timeframe. The benefit here is that if the company’s stock price rises, the employee can snag these stocks at a great discount. They can immediately resell the stocks for a healthy profit or hold onto them longer. 

Most employer stock option plans fall into one of two categories: 

Incentive stock options (ISOs)

These are generally only available to a handful of key employees and the top managers of the company. Consultants and non-employee directors are not eligible for these options. These stock options are usually offered by publicly-traded companies or private companies that may go public in the future. 

With ISOs, your employer will grant you a specific number of stocks you’re allowed to buy for a preset price at any point over the next 10 years. So if they grant you the right to buy 1,000 shares at today’s price, then next year the stock price doubles, you still get to buy those shares at the lower share price. You can resell the stocks right away or hold onto them for longer. 

There are other factors and rules to consider if you have an ISO compensation benefit, so it’s always smart to discuss your specific plan and vesting schedule with your advisor. 

Non-qualified stock options (NSOs)

 The second main type of ESO is non-qualified stock options. These differ from ISOs because they can be given to former employees, consultants, and advisors. With an NSO plan, you’re given the right to buy a preset number of shares at a designated price during a limited timeframe. That price is usually the same as the stock price the day these options are granted. If you choose not to buy your allotted shares during that time frame, the option expires. 

When do you actually “own” the employer stocks? 

The point of employer stock plans is to encourage employees to stick around and help build the company long-term. So in most cases, you have to be with your employer for a certain length of time before you actually take ownership of the stocks. 

Your actual ownership data of the stocks depends on when you exercise your option. If you don’t purchase your allocated stocks within the designated time frame, the options expire and you don’t technically own the stocks at any point. 

When do you pay taxes on employer stocks?

When you’re liable for taxes on those stocks depends on what type of plan your employer offers. For ISOs, you don’t have to report any taxes when you’re granted the option or when you exercise it. You’re not required to pay taxes until you sell your stocks. Once you sell, you’re taxed at the capital gains tax rate, which is probably lower than your income tax rate. 

 In the case of NSOs, you have two main tax events: when you exercise your option to buy the stocks and when you sell those stocks. When you exercise your buy option, if the price you purchase the stocks for is less than their current market value, that difference is added to your reportable income tax, increasing your tax burden. You’ll have one more tax event later, a capital gains tax, when you sell the stocks. 

There are other tax considerations to keep in mind when it comes to both ISOs and NSOs, like how long you hold onto the stocks once you exercise your option. For more detailed information, let’s talk about your particular situation. 

Next up, an overview of restricted stock units

Restricted stock units (RSUs) aren’t stock options. They’re a grant of stock that vests over a set period of time, often four years or once the employee hits key milestones in their career. While RSUs do give employees interest in the company (and a strong reason to stick around) they don’t technically provide any value until they vest. 

When do you own those RSUs?

This depends on your company’s vesting schedule. Generally, a portion of your total allocated RSUs vest each year, once you’ve hit the required milestone or time with your company. That means each year you work for your company (once your milestone or time requirement has been met), a portion of your allocated shares become your own, to sell or keep. If you leave the company before all your shares have been vested, you typically must forfeit the remainder of that benefit. But the shares you earned up to that point are yours to keep. 

When are RSUs taxed?

Unlike with stock options, the full value of your RSUs is counted as ordinary income in the year they vest. That tax bill adds up fast! To help offset that cost, many companies will automatically sell a portion of your new RSUs to cover the taxes. 

Here’s where an advisor really comes in handy: At that point, employees must decide if they want to sell off the rest of their shares or hold onto them longer. Selling right away minimizes your capital gains tax on the value increase, but if your company is healthy, those shares may continue increasing in value. Every individual situation is unique and should be considered independently.  

Watch your risk when it comes to stock options

Holding a significant amount of employee stock can be a great work benefit, but it can also open you up to significant risk. To protect your assets from market fluctuations and drops, your portfolio should be diversified. If everything in your portfolio is moving in the same direction, it’s time to diversify! 

Exercising your stock options comes with overexposure risk and major tax considerations. Before you make a decision, always talk to a financial advisor about your particular situation. 

Got stock options? Cook can help!

Because of the different kinds of equity compensation available, these tax and ownership answers can vary by situation. Again, consider working with a financial advisor to consider all your options. Here at Cook, our team helps you choose the best options, reduce your taxes, and invest wisely, so these benefits don’t become burdens down the road. 

If you have questions about your employer’s stock plan, just reach out. Grab a 15-minute spot on our calendar or send us a message below. We look forward to connecting with you!

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