Have you ever looked at your compensation package and thought, “This looks valuable, but what am I supposed to do with it?” You’re not alone.
Many of the executives we work with want to make smart decisions about their equity, but they don’t always feel confident about the details. That’s why we put together a short video explaining the basics of RSUs, ISOs, and ESPPs.
If you have any questions, the CGN Advisors team is here to help. Reach out today for a free consultation.
Transcript
Hi, I’m Jamie Bosse, Lead Advisor with CGN Advisors. If you’re a corporate executive, chances are part of your compensation includes company stock. And while stock plans can be a great opportunity to build wealth, they often come with rules, risks, and tax implications that you need to understand.
In this video, I’m going to walk through the three most common types of employee stock compensation: restricted stock units, incentive stock plans, and employee stock purchase plans.
What Are Restricted Stock Units (RSUs)?
Let’s start with restricted stock units or RSUs. These are the simplest and most common types of equity compensation. Think of them as a promise from your company to give you shares of stock when certain conditions are met.
Most often, RSUs are earned by staying with the company for a certain amount of time. This is called vesting. Sometimes performance goals are part of this equation as well.
But here’s the key point, you don’t have to buy the RSUs. There’s no action needed on your part until they vest. Once they vest, you receive the shares outright, and the value of them is taxed to you as ordinary income that year. From there, you have to decide if you’re going to hold the shares, sell the shares, or use them for your overall financial strategy.
The simplicity of RSUs is nice, but the timing of the vesting and how it fits into your overall tax picture is something we would definitely want to plan around.
How Incentive Stock Options (ISOs) Work
Now let’s talk about incentive stock options or ISOs. These give you the right, not the obligation, to purchase company shares of stock at a certain price. The set price is often called the strike price or exercise price.
Here’s where ISOs are different from RSUs. You have to choose when to buy the shares and when to sell them. That gives you more flexibility but adds a layer of complexity. When you meet certain holding requirements, the ISOs can have favorable tax treatment. Specifically, if you hold the shares for at least one year after exercising and two years after the grant date, your gains may qualify as long-term capital gains rather than ordinary income. But if you sell too early, you lose that benefit.
This is one of those areas where it’s really good to look at your full financial plan before making any decisions.
Understanding Employee Stock Purchase Plans (ESPPs)
And the third type of employee compensation plan we see frequently is the Employee Stock Purchase Plan, or ESPP. This plan lets you buy company stock at a discounted price through payroll deductions. Here’s how it works.
You enroll during a specific offering period, set aside a portion of each paycheck, and at the end of the period, your company uses those funds to buy the shares for you, typically at a discount up to 15%.
The benefit here is clear, you’re buying your company stock at a discount. But like with the other plans, tax rules apply. And when you sell the shares, it impacts your tax situation.
With ESPP plans, it’s important to know what a qualifying disposition is because that impacts whether the sale of your shares is taxed at ordinary income or capital gains rates.
Example: Comparing RSUs, ISOs, and ESPPs
Let me give you a simple hypothetical example to show the difference between these plans.
Let’s say your company stock is currently trading at $50 per share. If you have 1,000 RSUs that vest today, you now own 1,000 shares worth $50,000. That entire amount is treated as ordinary income for tax purposes.
If you have $1,000 in incentive stock options with a strike price of $30 and you decide to exercise them while the stock price is at $50, you pay $30,000 to buy shares worth $50,000. On paper, your gain is $20,000. And how and when you sell these shares determines how that gain is taxed.
With an ESPP plan, you may have bought the same $50 stock at a 15% discount. So around $42.50 per share. That immediate gain of $7.50 per share could be taxed as income or capital gains, depending on how long you hold it.
As you can see, each plan has its own mechanics and tax implications.
Managing Stock Compensation Within a Financial Plan
Most people don’t get to pick and choose what type of equity compensation they receive. Your company sets the plan, but you control how you manage it.
We help our clients understand their plans, know the tax rules, avoid over-concentration risks, and make informed decisions that support their long-term goals.
Work With CGN Advisors
Your stock compensation is part of your financial picture, but it’s not the whole picture.
At CGN Advisors, we work with professionals across the country who want guidance, not guesswork. To schedule a meeting, call our Manhattan office at 785-340-3434.