Demystifying 'Equity Compensation'

Posted: Updated:

Does your employee incentive package include something called "equity compensation?" If so, congratulations! If all goes well, equity compensation can increase your personal net worth. What is it and how does it benefit you?

While equity compensation can be a valuable asset that impacts your personal bottom line, it is also one of the most misunderstood forms of earnings. Developing a savvy strategy for managing it is key to enjoying the full benefit of this perk. Here’s some info that can help.

Public and private companies, especially startups, often offer employees non-cash payment in the form of shares in the company. Giving ownership in the company is an incentive for employees to work harder so the business grows.

So what's in it for you, the employee? As the company grows and prospers so does your net worth. But you shouldn't just sit back and enjoy the ride. To maximize the advantage of this asset, you need to understand the basics about equity compensation and develop a strategy that works best for your needs.

Know What Flavor You've Got

All equity compensation is not the same. Each type has its own rules and tax consequences. It's important to know the type of equity compensation that you’re being offered.

Stock Options. With stock options, you can buy shares of the company's stock at a discounted or "set" price. The purchase price or exercise price is usually the price of the company's stock on the day the options are granted. Typically there's a waiting period before you are allowed to "exercise" the options. There's also an expiration date. You may receive non-qualified stock options (NQSO) or incentive stock options (ISO). The type of options you own will impact the taxes you pay.

  • NQSOs are taxed when you decide to purchase the stock. You'll pay ordinary income tax on the difference between the fair market value at the time of exercise and the exercise price. For example, if the current fair market value is $18 and you have the right to purchase the stock at $10 (exercise price), you will be taxed on the $8 at ordinary income tax rates.
  • ISOs are taxed when you sell the stock you received from the exercise. Depending on the length of time you hold the stock, long-term or short-term capital gains taxes will apply to the sale proceeds.

Restricted Stock. With this type of equity compensation, you receive shares of company stock, but you aren't allowed to sell until predetermined restrictions lapse. If you leave the company prior to that time you may forfeit your shares of stock.

The value of restricted stock is typically taxed as ordinary income on the vesting date - the date the stock is yours to sell. If you sell on your vesting date, you won't need to pay any additional tax liabilities. However, if you hold the shares, you'll be taxed on any gains attained between the vesting date and the sale of the stock. Depending on the holding period, short-term or long-term capital gains tax will apply.

Do you anticipate the stock price will increase before your shares vest? If so, you may want to elect to pay taxes when your restricted shares are granted rather than waiting until they vest at a potentially higher value. To do this, submit a Section 83(b) election within 30 days of receiving the stock.

Stock Appreciation Rights. Similar to stock options, SARs allow you to benefit if the company's stock price rises over a designated period of time. Assuming the stock price increases within the designated time frame, you'll receive the value of the increase in either stock or cash without having any skin in the game. Let's say you are granted 100 SARs and the stock price increases by $8 per share over a set period of time. You'll receive $800 - the value of the appreciation of 100 SARs at $8 per share. That $800 will be taxed at ordinary income tax rates.

Create a Proactive Plan

If your employer provides equity compensation, talk with your financial advisor about the best strategy for managing it. A large bonus awarded in stock options, restricted stock, or SARs can have a significant impact on your taxes as well as your investment portfolio. Working with your financial advisor, the tax impact can be planned for and your portfolio’s diversification can be maintained.

Summary

Equity compensation isn’t a traditional income stream, but it doesn’t have to be confusing. Understanding how your equity compensation plan works and coordinating it with your overall investment strategy will move you closer to your financial goals.

Sarah Mahaffa, CFP is a Wealth Advisor with Bedel Financial Consulting Inc., a wealth management firm located in Indianapolis. For more information, visit their website at bedelfinancial.com or email Sarah.

  • Perspectives

    • Tax Planning: Now’s the Time to Tackle It!

      Year-end is still months away, but smart investors have already begun their tax planning. Spending time analyzing your capital-gain situation could benefit you come next April 15th, no matter what investment vehicles you use - individual securities, mutual funds, exchange traded funds, or others. Here's how…

    More

Subscribe

Name:
Company Name:
Email:
Confirm Email:
HTML
INside Edge
Morning Briefing
BigWigs & New Gigs
Life Sciences Indiana
Indiana Connections
INPower
Subscribe
Unsubscribe

Events



  • Most Popular Stories

    • Indy Hotels Among Top in Midwest

      Three Indianapolis hotels are among Condé Nast Traveler's Top 25 Hotels in the Midwest. The rankings include two hotels that have made the list three years in a row and one making its debut. The JW Marriott Indianapolis ranks third on this year's list, followed by The Conrad, which is eighth and Ironworks Hotels appearing on the list for the first time at number 17. You can see the full rankings by...

    • Ambrose Amps up Ambition For Old GM Stamping Site

      An Indianapolis-based developer has greatly expanded its original investment plans for the city's former GM Stamping Plant site. Ambrose Property Group's vision now includes projects totaling nearly $1.4 billion, more than doubling the $550 million scope detailed last year. During a community event Friday, the company and Mayor Joe Hogsett announced the name of the more than 100-acre, downtown district: Waterside. Plans now call for...

    • Indy Airport Scores Top Honor Again

      Indianapolis International Airport has again been named Best Airport in the United States by a global leisure publication. The Condé Nast Traveler recognition is the fifth straight for IND. The Best Airport designation is part of Traveler's annual Readers Choice Awards, which is built on feedback from more than 100,000 comments and millions of ratings. In addition to airports, favorites were tallied for hotels, resorts and destinations.

    • Daniels Envisions Purdue, Region as 'Cooler Place'

      Purdue University President Mitch Daniels says a more than $1 billion live, work, play development on the West Lafayette campus will be a magnet for attracting and keeping top talent in the region. The Discovery Park District is part of a 30-year vision to transform the west side of the Purdue campus and create a "preeminent environment" for educational, economic, cultural and community activities in the region.

    • NTN Driveshaft Proposing $90M Expansion

      NTN Driveshaft Inc. in Columbus is planning a $90 million expansion. In a tax abatement request with the Bartholomew County city, the automotive component supplier said the investment will lead to 74 new jobs and help retain a current full-time workforce of nearly 1,600. NTN Driveshaft is one of the largest employers in Columbus and last year, it opened a more than $140 million facility in Anderson. It launched operations in Bartholomew County in 1989 and says...