Equity compensation may be common in Silicon Valley—but few truly understand how it works. We wrote this short guide because of the confusion. We describe:

  • The types of equity compensation that you are likely to receive as a tech industry professional
  • How each type works
  • The process for exercising it
  • Potential tax issues to be aware of

We hope this guide provides you with a foundation to make smart decisions about your financial future.

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In 13 chapters and over 200 pages, Bruce covers the finance topics common to people working in technology industries, including equity compensation, investing, housing, taxes, and liquidity events.

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Non-Qualified Stock Option (NSO or NQSO)

An employee non-qualified stock option gives you the right to buy a specific number of shares of your company’s stock at a specific price for a specific amount of time.

You exercise your option by paying the specified price—known as the strike, exercise, or grant price—for the number of shares you want to purchase. The strike price is usually equal to the value of the stock on the day you received the option.

Because the strike price is fixed, the value of your stock option increases more in percentage terms than the value of the company stock as the stock price increases.

Stock options are normally subject to vesting, which means you may exercise your option only after you have worked for your employer for the required time. Your option ends and loses its value when you leave the company or the option expires.

When you exercise your option, you can either sell or hold the purchased shares. Once you exercise your option, the difference between the stock price and the strike price is taxed as ordinary income. There are no tax costs when you receive your option.

 
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Incentive Stock Option (ISO)

While otherwise similar to a non-qualified stock option, an incentive stock option has tax-saving features that an NSO does not have.

Under the regular tax rules, when you exercise an ISO, any gain in value resulting from an increase in the stock price above the strike price is not taxed. The gain is taxed when you sell the shares.

If you hold the shares for two years from the date you received your option and one year after you exercised your option, then any gain will be taxed at the long-term capital gain tax rates instead of the higher ordinary income tax rates.

However, under alternative minimum tax (AMT) rules, the gain is taxed when you exercise your option, which depending on your individual circumstances, can negate much of the regular tax savings.

As with non-qualified stock options, there are no tax costs when you receive your option under regular income tax or AMT rules.

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Restricted Stock

Restricted stock is company stock your employer gives to you as part of your pay that you cannot sell or transfer until certain conditions have been met.

Typically, your ownership in the stock vests, meaning its restrictions are removed, over time or as company goals are met. Once your stock is vested and its restrictions are removed, you own the shares and may sell or transfer them.

Restricted stock is taxed when it vests, not when you receive it, as ordinary income. Your taxable income is equal to the market value of the stock when it vested.

After your shares are vested, the tax rules for capital gains and losses apply.

Restricted Stock Unit (RSU)

A restricted stock unit is a pledge by your employer to transfer shares of company stock to you when certain conditions have been met.

Typically, your restricted stock unit vests and is converted to shares over time or as company goals are met. Once your RSU converts to shares, you own the shares and you can sell or transfer them.

A restricted stock unit is taxed as ordinary income when it vests and converts to shares, not when you receive it. Your taxable income is equal to the market value of the shares transferred to you.

Once you have received and own shares, the tax rules for capital gains and losses apply.

RSUs do not receive dividends because dividends are paid only to actual shares. However, some companies pay an amount equal to the dividends you would have received if you held actual shares.

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Employee Stock Purchase Plan (ESPP)

An employee stock purchase plan allows you to purchase shares of your employer’s stock at a discount of up to 15% or more from market value.

ESPPs are offered primarily by public companies.

You fund the purchase of shares over time with payroll deductions. The amount you invest is withheld from your paycheck and collected during the offering period, which is typically six to 24 months.

At the end of the offering period or an interim purchase period, the plan administrator buys shares with your collected funds and deposits them to your account.

Many ESPPs feature special “lookback” pricing, which allows you to buy shares at 15% off the lower of the price at the beginning or end of the offering period.

The IRS limits the amount you can contribute to $25,000 per year.

Conclusion

We hope this guide has given you a solid start in understanding the types of equity compensation you can receive as a high-tech professional in Silicon Valley. With a strong understanding, you can make better decisions about how to use your compensation to reach your financial goals.

At Parkworth Wealth Management, we’ve been providing comprehensive wealth management services to high-tech professionals for years. If you would like to discuss how your equity compensation can be incorporated into an overall plan to realize your goals now and in the future, please contact us for a complimentary consultation.

 
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Want This Information in PDF?
Download the Ebook!

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Personal Finance for Tech Professionals:
Get Notified When the Book Launches

If you would like more information about managing your finances and building wealth, check out Personal Finance for Tech Professionals in Silicon Valley and Beyond, written by our firm’s founder, Bruce R. Barton, CFP® CFA.

As founder of Parkworth Wealth Management, Bruce has in-depth knowledge of the financial concerns common to high-technology professionals. His book covers:

  • Spending and savings
  • Investing
  • Equity compensation
  • Housing and real estate
  • Family matters
  • Taxes
  • Liquidity events (IPOs and acquisitions)
  • Retirement
  • Your legacy
  • Do-it-yourself personal finance vs. hiring an expert
  • Helpful next steps, checklists, and resources

Sign up today to be notified when the book launches.

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