Stock options and restricted stock units (RSUs) are common forms of equity compensation offered by employers to their employees. While they can be a valuable part of an employee’s compensation package, they also have important tax implications that should not be overlooked. In this post, we will provide an overview of the US taxation of stock options and RSUs.
What are stock options and RSUs?
Stock options and RSUs are forms of equity compensation that allow employees to acquire an ownership stake in their employer. Stock options give employees the right to purchase company stock at a predetermined price, known as the strike price, at a future date. RSUs, on the other hand, give employees the right to receive company stock or its cash equivalent at a future date, usually upon the satisfaction of certain vesting requirements.
Taxation of stock options
The taxation of stock options depends on the type of option granted. There are two types of stock options: incentive stock options (ISOs) and non-qualified stock options (NSOs).
ISOs are generally only available to employees and are subject to special tax treatment. If certain requirements are met, ISOs are taxed as long-term capital gains when the stock acquired through the option is sold. This means that the gains are taxed at a lower rate than ordinary income.
NSOs, on the other hand, are taxed as ordinary income when exercised. The difference between the fair market value of the stock on the exercise date and the strike price is treated as compensation and subject to payroll taxes. When the stock is sold, any additional gains or losses are taxed as capital gains or losses.
Taxation of RSUs
RSUs are taxed differently than stock options. The value of RSUs is taxed as ordinary income when the shares are delivered to the employee. This means that the value of the shares is included in the employee’s taxable income for the year in which they are received, and subject to payroll taxes.
Once the shares are delivered to the employee, any gains or losses upon sale are taxed as capital gains or losses.
Tax planning for equity compensation
Given the potential tax implications of equity compensation, it is important to engage in tax planning to minimize your tax liability. Some strategies for tax planning include:
- Planning the timing of the exercise of stock options or receipt of RSUs to take advantage of the most favorable tax treatment.
- Utilizing tax-deferred retirement accounts, such as a 401(k), to reduce taxable income.
- Considering tax-loss harvesting strategies to offset capital gains.
Conclusion
Equity compensation can be a valuable part of an employee’s compensation package, but it is important to understand the tax implications of stock options and RSUs. Tax planning can help minimize your tax liability and maximize the benefits of your equity compensation. If you need help navigating the complex world of US taxation, JTT Accounting is here to help. Contact our team of experienced tax accountants today to schedule a consultation.