Stock Options and Restricted Stock – What You Need to Know About Taxes
Executive compensation plans, including stock-based compensation, are a great way for companies to attract and retain top talent. Understanding the tax implications, however, can be a daunting task.
Many variables come into play, including plan type, qualified or non-qualified status, holding periods and more. For busy professionals, just finding time to focus on this can be hard.
That said, it’s important to understand the basics so you can make informed decisions. Here, we provide a summary of the tax implications on the most common types of plans we see: stock options and restricted stock.
The taxation of stock options
The graph below summarizes the tax treatment of Non-Qualified Stock Options (NQSO) and Incentive Stock Options (ISOs):
| NQs | ISOs | |
|---|---|---|
| Holding Requirement | None | Holding period to receive preferential tax treatment |
| Tax Due | Ordinary Tax due at exercise | No tax at exercise if requirements met, but may trigger AMT |
| FICA Due | FICA due at exercise | Cap gains at disposition and no FICA if holding met |
With NQSOs, the tax occurs when you exercise, not when the options are granted. The tax is the same whether you hold the stock after exercising or not. Unlike ISOs, there is no required holding period from a tax perspective. Because of this, it’s important to work with your tax professional and Corient Wealth Advisor to understand and prepare for the associated withholding and estimated tax payments.
ISOs and the AMT trap
ISOs should always be analyzed carefully before exercise since the spread can trigger the dreaded alternative minimum tax (AMT). Depending on how well your options have performed, the amount of AMT could be substantial.
In addition, since the stock must be held for a minimum period to get preferential tax treatment (two years from the grant date/one year from the exercise date), there is the added risk of the stock falling in value. It’s possible to owe more in AMT than the stock is ultimately worth!
How can you avoid this? You can do what is called a disqualifying disposition. This means exercising and selling your ISO shares in the same calendar year. That effectively turns them into NQSOs. With this strategy, you can erase AMT and pay ordinary tax on the spread at the time of disposition.
It may be best to transact ISO shares early in the year so you have as much time as possible to see how the stock performs.
Restricted stock
The taxation of restricted stock depends on the type of plan. There are two major types: RSUs and RSAs.
Restricted stock units (RSUs)
RSUs are a promise to transfer stock once vesting conditions are met. With RSUs, executives have few options to control their tax bill. The RSU value is taxed as ordinary income when it vests.
| Restricted Stock Units (RSUs) |
|
|---|
Here’s an example. Say you have 1,000 RSUs vesting 100% in 2025. If the stock price on the vesting date is $10 per share, you will realize $10,000 of ordinary income. Now, let’s say the shares go up in value, and you sell them for $12 each in 2026. You will realize $12,000 from the sale and have a $2,000 capital gain.
Restricted stock awards (RSAs)
These represent an actual stock transfer, subject to certain conditions and restrictions.
| Restricted Stock Awards (RSAs) |
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|---|
The big difference with RSAs compared to RSUs is the availability of something called an 83(b) election, which is a mechanism that permits you to elect to pay tax on your stock reward at the grant date when it may be less costly rather than at a later date when it may be more costly. You can read about this election in detail in this article about simplifying restricted stock.
As you can see, there are many complexities. Your professional tax advisors and Corient Wealth Advisor can help you navigate the nuances and make informed decisions.
ABOUT THE AUTHOR
Gary Pattengale, CPA, CFP
Gary is a Wealth Advisor in our Itasca, IL, office. He specializes in executive and stock-based compensation plans, including stock options, restricted stock and deferred compensation. He combines his tax knowledge, executive compensation experience and capital markets expertise to help clients reduce their tax burdens and achieve each of their unique goals.
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