Different Options For Handling Stock Options (RSU's & NSO's)

There are several different ways for employees to handle stock options. In this article, we'll discuss two stock option types,  Restricted Stock Units (RSU's) & Non-Qualified Stock Options (NSO's)...

​It is becoming more and more common these days for employers, especially newer companies, to offer employees a compensation package that includes stock options. Two of the most common options are RSU’s & NSO’s.
 
How you handle these options can have a big impact on the tax implications, as well as your bottom line with these stocks.
 
RSU’s & NSO’s both carry similar tax handling. The process with these stocks generally consists of 4 steps:

1. Grant – employees are given options with a set purchase price…either $0 cost, a discount, or fair market value (FMV)
2. Vesting – options become available according to a set schedule
3. Exercise – employees purchase stock at the exercise price set at time of grant
4. Sale – stock disposed of by employees at fair market value

 
These stocks have a two-step taxation:

1. At Exercise – ordinary income realized on the spread (discounted exercise price as compared to fair market value)
2. Upon Sale – capital gain (or loss) based on sales price minus cost basis (cost basis = exercise price + spread)

 
Example:
After being vested, an employee exercises the granted option to purchase 1,000 shares at a $15/share agreed-upon price at grant date. FMV at exercise = $40/share.
 
Ordinary income of $25,000 is realized at exercise (spread = $40-$15...times 1,000). This income will be added to the employees W2 and reported on the tax return accordingly.
 
If the employee then sells these 1,000 shares at $50/share, that employee will have capital gain income of $10,000 (gain = $50-$40...times 1,000). A 1099-B form will be generated and reported on the tax return accordingly.
 
Options in stock handling:

1. Exercise and immediately sell all shares
2. Exercise and then “sell-to-cover” (sell some shares to cover taxes upon exercise)
3. Exercise and hold all shares

 
Which option is best for the stock-holding employee depends on how much the employee likes the stock, and how much cash the employee has available for taxes.
 
If the stockholder doesn’t feel the stock has potential to increase in price moving forward, that employee might choose the first option to exercise and immediately sell all shares. This allows the employee to essentially take profits off the table right away and not have to worry about future stock price depreciation.
 
If the stockholder loves the stock but doesn’t have cash to pay the taxes upon exercise, this employee will likely elect the second option, which allows selling some shares to cover the taxes, but retain most shares to potentially gain from future stock price appreciation.
 
If the stockholder absolutely loves the stock and has cash to cover the taxes due upon exercise, this employee might choose the last option, which has the employee keeping all stock for the greatest potential benefit from appreciation.
 
Every situation is unique and should be strategized accordingly. Feel free to contact us with questions as it pertains to your specific situation…we’re happy to help!