Including Equity Compensation in a Financial Plan

There are many types of equity compensation, including: restricted stock units and awards, employee stock purchase plans, stock options, performance stock, and stock appreciation rights. Each has unique characteristics, so it's important to familiarize yourself with the ins and outs of the equity type you have. A summary of the common types are below, but we suggest taking the time to read your stock agreement for more specific details.

Companies can compensate you in the form of restricted stock units (RSUs) or restricted stock awards (RSAs). RSUs and RSAs are a way for your company to compensate you with shares of company stock. Such grants are "restricted" because they have certain conditions attached (e.g., length of employment), and you generally can't sell or transfer the shares until they vest. However, once they vest, they're generally yours to keep.

Learn more about how restricted stock works.

An employee stock purchase plan (ESPP) is an optional program that may be offered to you by your employer. ESPPs allow you to buy company shares at a discounted price during certain times of the year. You select how much money you'd like to set aside (up to a limit) to purchase the stock, and your employer deducts that amount from your after-tax paycheck. The money is held by your company until the purchase date when the shares are automatically purchased on your behalf.

Learn more about how ESPPs work.

With stock options, you have the opportunity—but not the obligation—to buy company stock at a specified price within a set period of time, no matter how much the price may fluctuate (up or down). The two main types of options are non-qualified stock options (NQSOs) and incentive stock options (ISOs). It's important to know what type of stock option you have because they're treated differently for tax purposes.

Learn more about how stock options work.

Performance stocks are like restricted stocks with a hitch—the shares are only released if the pre-established performance goal(s), defined by the award agreement, are met by an individual, team, or company. If the performance goals haven't been met, then no stocks are released. These grants can be in the form of performance stock awards (PSAs) but are most commonly in the form of performance stock units (PSUs).

Learn more about how performance stock works.

Stock appreciation rights (SARs) have some similarities to stock options. You potentially benefit from appreciation in the stock's value above a specific price within a set period of time. If the stock's value climbs during that period, you can receive the gains in either cash or stock, as allowed by the award agreement. If the value falls below the specified price, you receive nothing.

Learn more about how SARs work.

Once you receive an equity award, it's a good idea to note any company trading periods that could affect your ability to buy or sell company stock.

• Blackout periods: A period of time (typically ahead of earnings season) during which you are prohibited from trading company stock (to prevent the appearance of insider trading). Your blackout period, sometimes referred to as a blackout window, may be listed in the award agreement provided by your employer. The trading window is the complement of it, when employees are allowed to trade.
• Lock-up periods (related to IPOs or acquisitions): A set amount of time where employees aren't able to sell their shares. You can face a lockup when your company goes public or is acquired. Lockups can also be called "market standoff" agreements.

It's also important to be aware of any holding requirements based on your role. Holding requirements occur post-vest and would require an employee to hold a certain amount of shares. This is much more common among executives than rank-and-file employees.

Also, be aware if you're subject to "pre-clearance" before trading company stock. Pre-clearance requires proactively seeking approval from the company's legal counsel or compliance to make a trade. This step is primarily for employees and executives that may hold material non-public information (MNPI).

Again, if in doubt, check with your company HR department to learn about whether any of these trading restrictions apply to you.

Equity compensation can be taxed in very different ways, so it's important to understand if and when you'll owe taxes, and how the taxes are determined. (Note: This section below refers to U.S. taxation. International tax filers may have different obligations.

Because taxes with equity compensation can be complex and intimidating at times, we recommend consulting with a tax professional as needed for guidance on strategies for your financial situation. Here's an overview of tax considerations for each type of equity compensation.

With restricted stock, taxes come into play twice: first, when the shares are delivered to you, which is typically when they vest, and then again when you sell them.

• Taxes upon delivery: You'll typically pay ordinary income tax based on the market price of the stock upon delivery.
• Taxes upon selling: When you sell your shares, you'll incur a capital gain or loss, depending on whether the value of the stock has increased or decreased. If you have a gain, you'll be subject to capital gains tax.

If you sell your shares within one year of receiving your shares, they're subject to short-term capital gains and will be taxed at your income tax rate. If you sell your shares more than one year after you receive them, they're subject to long-term capital gains and can be taxed at a lower rate.

The tax rules for RSAs are similar to RSUs, with one potential tax benefit. RSAs let you take advantage of the 83(b) election, which allows you to report the stock award as ordinary income in the year it's granted rather than the year it vests. This is advantageous if you anticipate making significantly more income and falling into a higher tax bracket in the future. Note: You need to make the 83(b) election within 30 days of the grant.

Learn more in our restricted stock tax guide.

The tax treatment for most ESPPs (i.e., qualified section 423 ESPPs) depends on how long you hold your shares before selling them. Depending on the time period, the sale (known as the "disposition") will be classified as either qualified or disqualified.

Qualified dispositions happen when the sale of ESPP shares occurs one year after the purchase date and two years after the grant date (offering date). Qualified dispositions have a more favorable tax benefit.

Disqualified dispositions occur when the sale of ESPP shares happens within one year of the purchase date or within two years of the grant date (offering date).

Learn more in our ESPP tax guide.

With NQSOs, taxes typically come into play twice—when you exercise the options and when you sell them.

• Taxes upon exercise: The price you pay when you exercise your options is called the "award price" (or "strike price"). The "spread" is the difference between the award price and the market price on the day you exercise. If you exercise your NQSOs and sell the stock in a single transaction, your spread is taxed as ordinary income, and your company will usually withhold taxes. Even if you subsequently exercise your NQSO and hold the stock, your spread will be taxed as ordinary income.
   

• Taxes upon selling: You're also taxed on any additional gains from the sale of the stock after you exercise the options. If you sell your shares within a year of exercising, you'll likely pay ordinary income tax on the short-term capital gains profit you make. If you sell your shares after more than one year of exercising, you'll likely pay long-term capital gains taxes, which typically have a lower tax rate than short-term capital gains on the profit you make selling your shares. If the market price falls and you sell at that lower price, that's a capital loss, and you won't owe any taxes.

  Learn more in our NQSO tax guide.

With ISOs, taxation generally doesn't occur until you sell the stock after exercising your options, potentially giving them a more favorable tax treatment than NQSOs. However, you must meet certain requirements to take full advantage. If you hold the stock for more than two years after the date the options were granted and more than one year after exercising them, the spread is taxed at the long-term capital gains rate, which is typically lower than your income tax rate. This is called a qualifying disposition. (Note: you may be subject to the alternative minimum tax (AMT) upon exercising).

If you sell before the above criteria is met, the spread at the exercise date is taxed as ordinary income, and any gains after the exercise date will be taxed as either a short- or long-term capital gain, depending on the holding period. This is called a disqualifying disposition.

Learn more in our ISO tax guide.

• Taxes upon delivery: When your shares vest and the performance is certified, they're assigned a fair market value (FMV) and are taxed as ordinary income.

In most cases, your employer will withhold income taxes by either holding back cash or stocks, depending on how the awards are paid out.

• Taxes upon selling: When you sell your shares, you may incur a capital gain or loss, depending on whether the value of the stock increased or decreased. You'll be subject to capital gains tax if your stocks increased in value.

If you sell your stock within one year of receiving your shares, they'll be subject to short-term capital gains and will be taxed at your income tax rate. If you sell your shares more than one year after you receive them, they'll be subject to long-term capital gains, which are usually taxed at a lower rate.

PSAs are taxed similarly to PSUs. However, PSAs, like RSAs, let you use the 83(b) election to report the stock award as ordinary income in the year shares are granted rather than when they vest. This election allows you to pay all the ordinary income tax upfront, so you won't be taxed again until you sell the shares. You need to make the election within 30 days of the grant.

Learn more in our performance stock tax guide.

You aren't taxed on SARs until you exercise the award as cash or stock. Then the spread is taxed as ordinary income.

In most cases, your employer will withhold income taxes on your behalf. Your employer will either hold back cash or stocks, depending on how the SARs are delivered.

If you receive stock and later sell that stock, you may incur a capital gain or loss, depending on whether the stock value increased or decreased after the exercise. If the sale price of your stock exceeds your cost basis (which is the price you paid to acquire the shares), you'll be subject to capital gains tax.

If you sell the stocks within one year of exercising your SARs, they'll be subject to short-term capital gains and taxed at your income tax rate. They'll be subject to long-term capital gains if you sell them after a year and can be taxed at a lower rate.

Once you familiarize yourself with the basics of your equity compensation and understand how it's taxed, it's important to consider how your equity fits into your financial plan so you can maximize its value. Here are four steps to take:

1. Identify your life and financial goals and assess your progress with them. Doing this exercise will also help you to understand how important your equity compensation fits within your overall plan. You can do this on your own or with help from a team of financial professionals.

2. Create a strategy to align your equity compensation with your plan. In other words, how do you use your equity compensation to help you achieve your goals? For many individuals, a strategy will likely need a combination of selling, holding, and/or hedging (if available to you) their stock.

   a. Have a plan to manage concentration risk. Generally, we suggest holding no more than 10% of your portfolio in any one stock. Granted, it's a little more difficult to do with equity compensation, but we still believe it's prudent to stay reasonably close to those guidelines.

3. Implement a tax-smart approach with your strategy. Different awards have different tactical approaches to help you pursue your desired outcome while being tax-smart. A trusted team of tax and financial professionals can help you strike the right balance of funding your goals with a tax-smart approach.
4. Monitor and adjust your plan and strategy at least annually, as your life, work, and income needs change.

One last piece of advice, remember that your equity compensation awards are a means to help you fulfill your life and financial goals. They help you get to where you want to go, not something to admire on a bookshelf. Your value lies elsewhere.