At Code, we're frequently working with candidates to help them get a better understanding of what equity compensation actually is. Many technology startups use it as part of their total compensation offering and we wanted to provide some context and resources that would help give clarity around the types of equity comp.
Compensation may include a form of equity, which will likely be in the form of stock options or RSU's. Here is a simple breakdown of what both are and how they differ:
What are Stock Options?
An employee can purchase equity in a company they are working for
No one has to purchase the stock, they just have the option
An employee will typically work for the company for a certain amount of time, then can buy stock (Refered to as the vesting period)
Stock is bought at a specified price that is typically lower than what it is worth on the market
Employer-granted stock options can be:
ISO's (Incentive stock options)
NSO's (Non-qualified stock options)
Tax varies between the two
What are RSU's (Restricted Stock Units)?
The company simply gives employee stock in the company when requirements are fulfilled.
Requirements can be fulfilled when performance requirements are met or when a time length is met.
There is no pricing involved with RSU's
RSU's are given in actual shares or cash eqivilent based on what the stock is worth at that point.
RSU's are less risky, as there is no money spent by employees to get the stock.
NSO's
Stock is taxed on the difference between the market price and the grant price (Called the spread)
Taxed as regular income
Subject to income tax and payroll taxes
If the shares are held for more than a year, gains or losses will be taxed at the lower, long-term capital gains rate
ISO's
Not subject to payroll taxes
Any increase in value will be taxed at the long-term capital gains rate when you sell, as long as you have held the shares for two years after they were granted and you hold the shares for at least a year after exercising them.
Are a preference item for the Alternative Minimum Tax, which is separate from regular tax laws.
AMT can make filing taxes more complicated, so professional help is suggested.
Check out these articles for a deeper dive into equity:
Smart Asset - Stock Options vs. RSUs: What’s the Difference?
Wealthfront - Stock Options vs. Restricted Stock Units (RSUs): What’s the Difference?
Cooley - ISO’s V. NSO’s: What’s the Difference?
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