The continuous changes in tax laws and how companies compensate their executives has brought headaches to many. Fortunately, many of these headaches and time spent worrying aren’t necessary.
Through working with us, our clients make educated decisions and avoid mistakes in regards to their stock bonuses and compensation. We specialize in evaluating options available and creating tax-efficient ways exercising stock options, restricted stock units, and long-term incentive bonuses.
The two most common forms of stock bonuses, or “long-term incentive”, are Restricted Stock Units and Stock Options. Although they are similar in many ways, they have huge differences that can affect ones decision about which to use, if given the choice. Many companies have shyed away from Stock Options and towards Restricted Stock Units (RSU) because of a change in tax reporting that requires them to expense employee stock options. Some companies, like Johnson & Johnson and Pfizer, actually offer both to employees and make them choose which they want.
Although these bonuses are great to receive, the decisions about when to exercise, what the tax consequences will be, and how one can protect these in case the stock drops, are extremely important and difficult.
Stock Options are the right to buy a specific number of shares in the future at a pre-set price (grant price). In general, options vest three years from the date of the grant, and option holders have an additional seven years from the vesting date to exercise them (exercise period). These are not like stock options that you hear on financial news or read about, they work very differently.
Restricted Stock Units (RSU) are a grant of units, with each unit, once vested, equal to a share of stock. Company stock is not issued at the time of the grant. However, when RSUs vest, you will receive one share of company stock for each RSU that vests. These are become much more popular after the market crashed in 2008 and due to changes in tax laws.
|Employee Stock Options||Restricted Stock Unit (RSU)|
|Value Over Time||Options have value if the stock price rises above the grant price, but could have no value if the stock price is at, or below, the grant price.||RSUs will always have value, whether the stock price goes up or down (unless the stock goes to 0). The value of your award will increase if the price goes up and decrease if it goes down.|
|Vesting||Typically 100% vested after 3 years. Sometimes they will vest at 1/3 per year.||Typically 100% vested after 3 years.|
|Term||Options expire 10 years after the grant date.||RSUs become actual shares on vesting. Then they are yours to hold or sell. Typically, when they vest, the company exercising will withhold a certain amount of taxes for you by selling shares and giving you the balance.|
|Taxation||In most cases options are taxed as income at the time of exercise, regardless of whether shares are sold or held. Taxes on gains also may need to be paid upon subsequent sale of shares.||As stated above, RSUs are generally taxed when they vest and shares are automatically sold.|