The Tax Impact of Stock Options and Restricted Stock

When companies recruit senior executives, they usually seek top performers who can help shape the future of the company and continue moving it forward. Finding the right executive for a given role is challenging, and with so much competition for premium talent, keeping these executives for years to come may be an even bigger challenge. Executive compensation plans, including stock-based awards, are a great way for companies to attract and retain top talent. Understanding the tax implications, however, may 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 element of executive compensation can be hard.

That said, it’s important to understand the basics so you can make informed decisions that are appropriate for your unique circumstances and objectives. Here, we provide a summary of the tax implications of 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):

With NQSOs, the tax occurs when you exercise the options, not when the options are granted. The tax treatment is the same whether you elect to receive cash or stock upon exercise. 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, as compensation income from stock options can be significant and vary from year to year.

ISOs and the AMT trap

ISOs should always be analyzed carefully before exercise, since the spread may trigger the 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 receive preferential tax treatment (two years from the grant date/one year from the exercise date), there’s the added risk of the stock price declining in value. It’s possible to owe more in AMT than the stock is ultimately worth!

How can you avoid this undesirable outcome? 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, at the time of disposition, you can erase AMT and pay ordinary tax on the spread. The spread is the difference between the price when you exercise the options and the grant price when the options were issued. In addition, depending upon the price you sell the shares at that same year, you may owe short-term capital gains tax on the appreciation (if the stock price is higher than when you exercised the options).

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.

Here’s an example. Say you have 1,000 RSUs vesting 100% in 2026. If the stock price on the vesting date is $100 per share, you will realize $100,000 of ordinary income. Now, let’s say the shares go up in value, and you sell them for $120 each in 2027. You will realize $120,000 from the sale and have a $20,000 capital gain. Note, in order for the capital gain to be treated as long-term, you must have held the shares for at least 12 months from the date the shares vested and were released to you.

Restricted stock awards (RSAs)

These represent an actual stock transfer, subject to certain conditions and restrictions.

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 award at the grant date, which may be less costly than paying tax at a later date when the stock may have increased in price. You can read about the 83(b) election in greater detail in this article about simplifying restricted stock.

As you can see, there are many complexities when it comes to stock-based compensation. Your professional tax advisors and Corient Wealth Advisor can help you navigate the nuances and make informed decisions designed to effectively manage your related tax obligations.

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