Your employer has a plan to provide a portion of your compensation via company stock. Is this a good deal? It can be! However, it is important to familiarize yourself with how the different forms of equity compensation work in order to maximize your potential return and minimize your tax implications. Let's examine a couple of common company stock compensation plans.
Restricted Stock Unit (RSU)
A restricted stock unit is a form of equity compensation companies use to reward their employees. RSUs are a promise to grant an employee a certain number of company shares at a specified future date. RSUs are a popular way to attract and retain talent. RSUs do not require the employee to purchase the shares; they are instead given the shares.
So, how do they work? Companies grant RSUs to an employee as part of a compensation package. The RSUs have a pre-determined vesting schedule—usually a specific time spent with the company. Sometimes the shares vest all at once. Sometimes they vest over a period of time—e.g., 25% each year. Once the shares vest, they convert to actual company shares and are yours to hold or sell.
The tax implications for RSUs are complicated, so it may be worth consulting a financial advisor or CPA. Typically, when RSUs vest, they are considered taxable income to the employee in the year they vest. After the RSUs convert to actual shares of the company, any future gains or losses from selling the shares are subject to either long- or short-term capital gains tax.
Employee Stock Purchase Plan (ESPP)
An Employee Stock Purchase Plan is a program offered by some companies that allow employees to purchase company shares at a discount. This gives employees an extra incentive to share in the stock's growth potential. The employee can elect to contribute a portion of their salary to a holding account over a specific period, usually six months. At the end of the period, the accumulated dollars will purchase company shares at a discounted price.
The discounted price varies by company. For example, some may offer a 15% discount from the stock's price at the end of the 6-months, while others may offer a 15% discount from the stock's lowest price during the entire 6-month period.
Tax implications can also get complicated with ESPP plans. According to J.P. Morgan, almost 80% of ESPPs are considered qualified. This means that no taxes are owed at purchase. However, when you sell the stock, there are tax implications, and the timing of sales is critical.
Employee Stock Ownership Plan (ESOP)
An Employee Stock Ownership Plan is an employee benefit plan offered by some companies to gift shares of stock. ESOPs are set up as trust funds to hold stock shares on the employees' behalf. The trust fund has an appointed trustee who acts as the plan fiduciary. Companies typically deposit stock or cash (used to buy shares) in the trust.
All eligible employees can participate in the program, typically after meeting certain eligibility criteria, such as tenure. Shares are allocated from the trust to employees, usually based on factors like salary or years worked at the company. Employees accumulate shares over their years of service, which are meant to be sold only at or after retirement or termination. Once this happens, a fully vested employee can sell their shares back to the company and receive a lump sum distribution.
Some plans allow a periodic distribution to ease the tax burden since the proceeds distributed from the shares are typically considered earned income. Alternatively, some ESOPs can be cashed out and rolled into an IRA, thereby deferring taxes until distribution from the retirement account.
At this point, you shouldn't be surprised that taxes for ESOPs can also be complicated. Age is often an important factor with ESOP taxes. Specific information can typically be found in the plan's guidelines.
Employers will provide their employees with other types of stock incentives beyond the three listed above. Although everyone's financial situation is different, it's typically beneficial for an employee to participate in these programs—especially if you are optimistic about the future growth of your company.
However, be careful to monitor the relative proportion of company stock versus your overall investment portfolio. You must also understand the tax implications of your company's specific program and have a plan to minimize any potential taxes.
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We have helped our clients answer these questions and more. If you want a clear understanding of your financial future, and need help making changes to reach your goals, schedule a consultation and we can get started.
The material has been gathered from sources believed to be reliable, however Bedel Financial Consulting, Inc. cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. To determine which investments or planning strategies may be appropriate for you, consult your financial advisor or other industry professional prior to investing or implementing a planning strategy. This article is not intended to provide investment, tax or legal advice, and nothing contained in these materials should be taken as such. Investment Advisory services are offered through Bedel Financial Consulting, Inc. Advisory services are only offered where Bedel Financial Consulting, Inc. and its representatives are properly licensed or exempt from licensure. No advice may be rendered unless a client agreement is in place.
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