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The ABC's of Stock Compensation

May 09, 2024 | The Baum Jackson Investment Group


Stock compensation can be financially beneficial, but also confusing. We’re here to help eliminate the confusion associated with this form of compensation.

Have you been told by your HR department that you have earned ISOs, NQSOs, or RSUs and realize that you have no idea what any of it means? With the proliferation of stock compensation, these terms are becoming more prevalent; we’re here to help eliminate confusion. 
First, stock compensation is an excellent way to reward and retain employees, but also align the goals and mission of the management team with employees across multiple layers within the organization. Although it is a great way to reward and compensate employees, it can become quite confusing with the various vesting and taxation rules associated with each type. 

  1. Stock Options
    • Incentive Stock Options (ISOs)1
      • ISOs are not subject to Social Security, Medicare or withholding taxes.
      • Strict parameters exist for who qualifies for ISOs.
      • ISOs are non-transferrable. 
      • Alternative minimum tax (AMT) could apply with ISOs. Please consult your tax advisor for further tax explanations. 
    • Non-Qualified Stock Options (NQSOs)1
      • NQSOs give you the right to buy a certain number of shares at a predetermined strike price.
      • These are the most common form of stock option.
      • NQSOs are not reported to the IRS until you exercise the options, so there’s a tax advantage embedded in the flexibility it offers2.
      • Taxes are due when you exercise NQSOs. At the time of exercise, the difference between the current stock price and the exercise price will be treated as ordinary income. Capital gains taxes will be realized upon the sale of the stock. Please consult your tax advisor for further tax explanations. 
      • Unexercised NQSOs can be transferred to others through divorce or gifting.
  2. Restricted Stock Units (RSUs)
    • RSUs are the most common type of equity compensation2.
    • RSUs vest over time (used as a retention tool), and upon vesting they are no longer restricted and are valued at the current stock price in the open market.
    • The value of the shares at the date of vest is taxed as ordinary income2.
  3. Employee Stock Purchase Plan (ESPP)
    • An ESPP is a program which allows employees to purchase company stock at a discounted price. 
    • Employees contribute through after-tax payroll deductions. 
    • There are two types of ESPPs: Qualified and non-qualified.

Please note that these examples, and the associated overview, are meant as an introduction into the world of stock compensation. These are some of the more common forms of stock compensation that can be offered to employees.

If you have questions pertaining to your specific stock compensation, we are happy to discuss in greater detail. At the end of the day, stock compensation is complex, but it is an important way for employers to create alignment within the organization and provide employees with ownership.
Employer-granted stock options can present complicated tax-related decisions.   As we are not tax advisors, we suggest you consult with your CPA when you are developing your strategy for holding, exercising, or selling your options.


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