With the end of 2021 around the corner, many individuals who work at both publicly traded and private companies may find themselves in a position where their employers have given them opportunity to receive equity compensation as part of their benefits package. There are two basic types of equity compensation – options and grants. Under those broad categories, there are many sub-types including restricted stock units, non-qualified stock awards or options, and incentive stock options. Typically, options and grants are subject to vesting periods, meaning a certain amount of time needs to lapse before you can actually benefit from these types of compensation. Equity compensation has been a valuable tool used by companies because it gives them an opportunity to preserve cash flow by replacing salaries or bonuses with equity and in turn can create a culture of ownership, incentivizing employees to think and act like an owner.

Equity compensation can be confusing for many though and can present complex questions such as: how do you evaluate your options, what are the grants actually worth, what could they be worth in the future, when should you exercise options, and what are the tax ramifications of receiving grants? I am not intending to answer all of those questions in this article as those are best answered in the context of your personal situation and should be examined in a comprehensive financial plan. I am hoping, however, that this article sparks discussion and serves as a starting point for equity compensation planning.

Stock Options

Stock options give employees the right (not the obligation) to buy shares of their company at a fixed price – otherwise known as the “exercise” or “grant” price. When an employee receives these options, it is generally not a taxable event because the grant price is equal to the stock price trading on the day of the award. This also means that at the date of grant, there is no discernable value to the employee. There are two primary types of options – Nonqualified stock options (NQSOs) and incentive stock options (ISOs).

For nonqualified stock options, typically there is no economic value on the date of the grant and thus no tax consequences of receiving these options. However, at the time of exercise of the option, what is known as the bargain element is considered to be W-2 compensation income. The bargain element is the difference between the grant price and the price of the stock on whatever day you decide to exercise. This bargain element is subject to payroll taxes and your holding period (short term or long term) begins at the date of exercise. NQSOs are the more common type of options granted to employees given their relative simplicity compared to their counterpart – incentive stock options.

Incentive stock options (ISOs) present a slightly different set of challenges for planning given their tax qualified nature and are subject to a handful of requirements under the Internal Revenue Code in order to qualify for their preferential status. These rules are often referred to as special holding period rules and in exchange for the satisfaction of said rules, there could be no regular taxable income due for individuals on the exercise of ISOs, rather there is potentially an alternative minimum tax (AMT) event where you must report the bargain element as an AMT adjustment item. At this point, if I went into AMT any more than that, you might immediately put this article down, so I will leave it there, just know there are specific holding period requirements that need to be met in order to have preferential tax treatment on the sale of ISO related stocks.

Share Grants

Share grants or stock grants are typically more straightforward than options and are more common for employees. They usually come in the form of one or both of the following: Restricted Stock Units (RSUs) and Performance Units.

Restricted stock is stock that could be forfeited by the employee if employment performance is not satisfactory or employment is terminated before the required vesting period is met. Due to this substantial risk of forfeiture, units are not taxable upon grant, rather taxed as shares vest (or become available to the employee) as W-2 compensation income and are taxed accordingly.

Performance units or performance stock grants often vest using company performance criteria over a certain amount of time. Like RSUs there is substantial risk of forfeiture and units are not taxable until shares vest.

Planning Considerations

We find clearly laying out what our clients have in their options and units is the first step to creating a plan of action. Helping clients understand the potential value of their equity compensation, and illustrating risks in the context of their financial plan, provides insight into how this type of compensation can be an incredibly effective wealth building tool.  That said, we also attempt to mitigate the common misunderstanding regarding equity compensation that generally results from a lack of company provided education. After we have a clear understanding of what benefit package a client has, we work with them and their tax advisors to develop a long-term tax strategy model to maximize lifetime wealth. Considerations include multi-year tax planning, risk analysis for the company, optimization of holding periods based on underlying equity compensation characteristics, and many more.


If you are the recipient of equity compensation or have more questions about how it works, I would encourage you to reach out to your client centric team or give Greenleaf Trust a call so we can help you clarify your long-term goals and how equity compensation appropriately managed can play a meaningful role in maximizing lifetime wealth.