Wednesday, March 1st, 2023
A popular form of equity compensation are employer stock options. With stock options, you have the “option” to buy a specific number of shares at a certain price per share, known as the strike price or exercise price.
With options, your employer allows you to choose when to exercise this opportunity if it falls within the allotted time. You may also be subject to a vesting schedule or black out period, before you can exercise your stock options. Many factors such as taxation, market value, and market conditions can influence your decision on exercising stock options.
RSUs vs. Employer Stock Options
At first glance, employer stock options and Restricted stock units (RSUs) seem one and the same. But that’s simply not the case. With employer stock options, the company grants you the ability to buy shares of its stock at a specific price. You have a choice to buy the stock, or not, at the agreed price before the expiration date.
Whereas with RSUs, the company grants you stock, and once vested it’s yours, you don’t have to purchase anything.
Stock Options Key Characteristics
- Exercise Price: Determined by stated price in option agreement
- Vesting: Usually awarded on a set vesting schedule
- Payment: Cash exercise, cashless exercise, stock swap
- Taxation: Taxed upon exercise and/or sale
- Common Uses: Popular with early or mid-stage start-ups
Restricted Stock Units Key Characteristics
- Exercise Price: No exercise price
- Vesting: Can be awarded on set vesting schedule or performance benchmarks
- Payment: No payment required
- Taxation: Taxed upon vesting
- Common Uses: Popular with late-stage start-ups and public companies
Types of Stock Options
There are two main types of employer stock options; they are nonqualified stock options (NSO) and qualified stock options (ISO). Familiarizing yourself with which stock options are included in your equity compensation agreement is crucial. NSOs and ISOs have different benefits and tax implications. It’s important to understand these key differences so you can make informed decision when exercising your options.
NONQUALIFIED STOCK OPTIONS (NSO)
Nonqualified stock options, also known as non-statutory options, or NSOs, are taxed at your ordinary income tax rate when you exercise the option. Upon exercising these options, you will receive shares of stock. The cost basis of the stock is equal to your exercise price, which is what you paid per share to acquire it. Companies may grant NSOs to employees, consultants, service providers, and other insiders.
INCENTIVE STOCK OPTIONS (ISO)
Qualified stock options, also known as incentive stock options, or ISOs, can qualify for special tax treatment if you play by the rules. To qualify for the tax advantages of ISOs you need to wait to sell the stock until at least two full years from the ISO grant date, and one full year from the exercise date. This is called a qualifying disposition; it is the most tax efficient strategy for dealing with these types of stock options. In addition, ISOs are reserved exclusively for company employees and insiders.
Have Employer Stock Options or Restricted Stock?
Here’s what to do next.
While employer stock and options can be a huge advantage for your financial success, you want to make sure you make the best decisions to improve your future.
Partnering with a fiduciary financial planner at Navalign can help you understand your options and make smart financial decisions that are in your best interest. We believe every investment decision should align with your personal values and financial goals. Our fiduciary approach ensures that your best interest always comes first.
Do you have questions or ready to make a decision about what to do with your shares? Contact us today to schedule a complimentary consultation to speak with an expert.