With such a competitive job market, especially for specialized roles, companies have begun to recognize the need for offering benefits that extend past PTO and 401(k) matching. For many companies that are public or are hoping to become public in the near future, equity compensation plans (ECPs) for employees have become a popular choice.
Equity compensation plans can vary in terms and conditions, but at their core, they all provide employees with special considerations when purchasing the company’s stocks. These are typically put in place to engage employees more deeply with the growth of the company, and are also useful when an owner desires to unwind their equity while keeping key employees in a business sale. While ECPs can be a lucrative benefit, it is important to understand tax planning implications they involve so you can develop strategies to make the most of your investments.
Types of Equity Compensation Plans
Restricted Stock Units
Restricted Stock Units (RSUs) give employees the option to purchase stocks at a fair value, which is often discounted or completely free. These options are restricted, typically requiring a set amount of employment years before they can be purchased, but they can be tied to a variety of metrics depending on the company’s structure.
When an employee is granted stock options, they are given the opportunity to purchase a defined number of shares at a defined price—regardless of the stock pricing when they complete their purchase. These options generally vest in accordance with a certain length of employment or the achievement of goals, at which point employees can exercise their option at any time before the expiration date.
Employee Stock Purchase Plans (ESPPs)
Under an ESPP, an employee sets aside money, usually through taxable payroll deductions, throughout an offering period to purchase stock. At the end of the offering period, the employee’s funds are used to buy shares, which are typically provided at a discount from the employer.
Equity Stock Option Plans (ESOPs)
ESOPs are the most common type of employee ownership plans in the U.S. Essentially, a company will set up a “trust fund” where it contributes cash for stock shares or places stock shares directly. As employees rise in seniority, they gain rights to more shares within the account. When they leave, they receive the stock and the company is required to buy it back at its fair market price—either estimated by an outside expert in the case of private companies, or at its current value for public ones.
Concentrated Equity/Non-Qualified Deferred Compensation Plans
Under a concentrated equity/deferred compensation plan, an employee is able to earn compensation in one year but receive the earnings in a different one—which can be quite advantageous for income tax purposes. Often, deferred compensation is disbursed after an employee retires which can lead to a different tax rate on the income than if they had received it while still employed.
Common Vesting Schedules for Equity Compensation Plans
Under a time-based vesting schedule, an employee earns their options or shares at defined intervals of time. Typically, you will need to remain employed for at least a year and will then have your stocks vest monthly or quarterly after that.
If an employee is on a milestone-based vesting schedule, stocks will be vested after a project is completed, goals are hit, or another defined metric is reached.
A hybrid vesting model is just what it sounds like—there will typically be a minimum length of employment required for shares to vest, and then a milestone or goal must be hit after that for the stocks to become fully vested.
If you need help understanding equity compensation and how it can impact your tax filings, we are here to help. Contact us today to learn more about our planning services and how we can ensure you get the most out of every dollar you earn.
Guardian, its subsidiaries, agents and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation.