Primer on Stock Options and RSUs

Kelsey Brennan |

Nonqualified Stock Options are the most common type of stock option. When you exercise in-the-money stock options, the difference between the exercise price and the market value is going to be taxable W-2 income to you, at ordinary income tax levels plus Social Security and Medicare taxes.

Incentive Stock Options offer tax benefits: after you exercise the options, if you hold the stock for at least two years from the date of grant and one year from the date of exercise, you receive favorable long-term capital gains tax treatment for all appreciation over the exercise price. Don't overlook the significant tax impact and sales may have upon calculations of alternative minimum tax (AMT); failure to plan for this can result in a shock come tax-time.

Restricted stock units (RSUs) aren't stock options – they're equity awards

Unlike stock options - which require the employee to purchase the option at the strike price - RSUs are just given to employees as equity awards, typically upon vesting. So unlike stock options which can become "underwater" if the market price is less than the price you paid when exercising the option (the strike price), restricted stock units will always have some value unless the stock goes to zero. Obviously, at that point, you would have other issues to contend with.

When granted, RSUs have no tax or income implications as they are still considered “unearned.” To earn the shares, employees must meet vesting requirements set forth by the employer. Many public companies will require time-based vesting but could also include other performance-related requirements, like reaching a target stock price. Private companies typically have a time-based vesting requirement in conjunction with an event-based requirement, such as an IPO. When RSUs vest they become common stock. The value of your equity grant will be determined by the current market value on the vesting date.