When it comes to equity compensation, stock options and restricted stock units (RSUs) are common incentives given to employees by their employers. These forms of equity compensation offer an opportunity for employees to share in the success of the company they work for, as well as provide a way to retain and incentivize key employees. However, stock options and RSUs come with tax implications that need to be understood for proper planning and overall financial wellness.
What are stock options and RSUs?
Stock options and RSUs are both forms of equity compensation that are commonly used by employers to incentivize and retain employees. Stock options give employees the right to buy company stock at a specific price, while RSUs give employees the right to receive company stock at a certain point in the future. Both are often granted as part of an employee’s overall compensation package, and serve as a way to align the interests of the employer and employee.
Stock options are often used to provide employees with an additional incentive to be successful, as the employee has the potential to profit if the company performs well. They usually come with an exercise price, or strike price, which is the price at which the employee can purchase the stock. On the other hand, RSUs are often granted without a purchase price and are instead granted as a promise to deliver stock at some point in the future. RSUs can also come with vesting schedules, which means the employee must remain with the company for a certain period of time before they can receive the promised shares.
How are stock options and RSUs taxed?
Stock options and RSUs are taxed differently, and it’s important to understand how each is taxed to avoid unexpected tax bills come tax season. Stock options are taxed when you exercise them, meaning when you buy the stocks at the agreed-upon price. Once exercised, they are subject to either ordinary income tax or capital gains tax. Ordinary income tax applies if you exercise the options and sell the shares within a year of exercising them. It is important to note that if you hold onto the shares for more than a year, any profit made from the sale is subject to capital gains tax.
On the other hand, RSUs are taxed upon vesting, meaning when you receive the stocks after the predetermined date. The value of the stocks is taxed as ordinary income and is included in your gross taxable income for that year. Once vested, you can choose to sell the shares immediately, or hold onto them and sell them at a later date, subject to capital gains tax.
What is the difference between capital gains tax and ordinary income tax?
Capital gains tax is a tax on the profits made from the sale of an investment, while ordinary income tax is a tax on your regular income. Capital gains tax is typically lower than ordinary income tax, especially if the shares have been held for more than a year. It is also worth noting that the tax rate for capital gains tax can vary depending on your income level.
How is the value of stock options and RSUs calculated for tax purposes?
The value of stock options is calculated as the difference between the market price of the stock and the exercise price. The value of RSUs is based on the market price of the stock on the vesting date. It is important to note that the value of RSUs is subject to change, and taxes owed may be dependent on the actual value of the shares upon vesting.
What is an AMT and how does it relate to stock options?
The Alternative Minimum Tax (AMT) is a separate tax system used in the United States to ensure that taxpayers pay at least a minimum amount of tax. If the regular tax on your stock options is lower than the AMT, you may be subject to pay the AMT instead. For employees with significant stock options, the AMT can be a concern, and it’s important to consult with a tax professional to fully understand the potential tax impact.
What is a capital loss and how can it affect your taxes?
A capital loss is when you sell an investment for less than what you bought it for. Capital losses can be used to offset capital gains, reducing your overall tax bill. Additionally, if you have more capital losses than capital gains, you can deduct up to $3,000 of net capital losses against your ordinary income. Understanding the implications of capital gains and losses is an important part of managing your overall tax liabilities.
Are there any strategies for minimizing tax liability related to stock options and RSUs?
One strategy for reducing tax liability related to stock options is to exercise them in years when your ordinary income is lower, potentially reducing the amount of ordinary income tax owed. This is because the value of the stock options is taxed at the time of exercise. Another strategy is to sell some of the RSUs upon vesting in order to have enough money to pay the taxes owed. This can be an effective way of managing the tax liability while still retaining some of the shares for long-term investment.
Are there any tax implications when stock options or RSUs are transferred in a divorce settlement?
Transferring stock options or RSUs in a divorce settlement can be a complex process that may have tax implications for both parties. It’s highly recommended to consult with a qualified tax professional to ensure both parties understand their tax liabilities and don’t inadvertently trigger unnecessary tax liability.
What happens if you receive stock options or RSUs from a foreign company?
If you receive stock options or RSUs from a foreign company, you may be subject to different tax rules and regulations, depending on the country of origin. Tax laws can vary widely depending on the country, and it’s important to consult with a tax professional who is familiar with the tax laws in both countries to fully understand the implications of receiving equity compensation from a foreign company.
What happens if you decide to hold onto your stock options or RSUs rather than sell them?
If you decide to hold onto your stock options or RSUs rather than sell them, you will not realize any capital gains or losses until you eventually sell them. Additionally, if you hold onto the shares for more than a year from exercise or vesting, any profit made from the sale is subject to capital gains tax. It’s important to track the cost basis of the stocks, which is the original price paid, to accurately determine any capital gains or losses when you eventually do sell the shares.
