Employee stock options vs. restricted stock

For an early stage or startup company, which type of equity incentive is better? In startupland, complexity should be avoided to keep legal and accounting costs down.

Instead, the recipient receives a unit award. Not stock, but a unit award. No 83 b election can be made on the receipt of a unit award because an 83 b election can only be made on the receipt of actual shares of stock. There is no tax due upon the receipt of an RSU, which is good, but here is the problem: The unit award will be subject to vesting.

When the units vest, the company will deliver the shares of stock to the award recipient. The shares of stock delivered will be taxable as ordinary income then, at that time. This is why in an early stage company, award recipients typically either prefer stock options or restricted stock awards.

RSUs can and do make a lot of sense for more mature companies, especially public companies that can provide award recipients with the ability to immediately sell shares to fund tax liabilities. Or companies that have significant cash reserves and that can help employees fund their taxes. Or companies that have a public offering planned in the reasonably foreseeable future. Stock options are not taxable upon receipt, as long as they are priced at fair market value.

This is nice, because the recipient can defer tax until option exercise. Stock options are also not taxable upon vesting. Another nice feature of stock options. A stock option is taxable at exercise—but the tax consequences will depend on whether the option was a nonstatutory or non-qualified stock option or an incentive stock option. I have written about this extensively in other blog posts.

See, for example, ISOs vs.

Stock Grants Vs. Stock Options - Budgeting Money

See also, Top 6 Reasons to Grant NQOs over ISOs. Options are good for this reason—the optionee can generally control the incidence of the taxable event—which is exercise.

How Do Stock Options and RSUs Differ?

Regardless of whether the option is an NQO or an ISO, the capital gains holding period does not start until exercise. Restricted stock awards can either be taxable upon receipt by making an 83 b election or will be taxable upon vesting if no 83 b election is made. Both situations are problematic. Thus, when considering whether to grant someone a stock award or a stock option, it is a good idea for companies to consider the ability of the award recipient to pay taxes today.

As Fred Wilson said , and I agree with him:. Each of the three choices; options, restricted stock, and RSUs, has benefits and detriments.

What could Congress do? Award documents vary widely in the wild, especially RSU award documents. And this blog post has made simplifying assumptions that may not apply in your particular situation.

Good luck and have fun out there! This is excellent Joe. I think your summary gives people a foundation to decide what makes the best sense. Another big issue for startups and equity awards is documenting them correctly and in real time!

They need to be treated with the same care as share issuances. I often see this advice to find a good tax advisor or lawyer for this sort of thing. But I see much less advice on how to choose such a professional. Enter your email address to subscribe to this blog and receive notifications of new posts by email. Joe Wallin Startup Law Menu. State Equity Crowdfunding vs. Posted on September 13, by joe. The Taxation of Stock Options Stock options are not taxable upon receipt, as long as they are priced at fair market value.

The Taxation of Restricted Stock Awards Restricted stock awards can either be taxable upon receipt by making an 83 b election or will be taxable upon vesting if no 83 b election is made. What Should You Do? One thing you could do is lobby your Congressional representatives to change the law. As Fred Wilson said , and I agree with him: Table Summarizing Some of the Differences in Award Types Restricted Stock Units Restricted Stock Awards Stock Options Taxation at Grant?

Stock Options, Restricted Stock, Phantom Stock, Stock Appreciation Rights (SARs), and Employee Stock Purchase Plans (ESPPs)

No Yes, if vested or an 83 b election is made No, as long as priced at fair market value Taxation Upon Vesting? Yes, because usually shares are delivered upon vesting; and there is ordinary income at that time at the then value of the shares.

Yes, if subject to vesting and no 83 b election was made No, as long as priced at fair market value Taxation Upon Settlement or Exercise? Twitter LinkedIn More Facebook Google Tumblr. You are dead right on. Casually approaching stock options can be a disaster.

I think Congress should repeal A as it applies to early stage and startup companies. Search Subscribe to Blog via Email Enter your email address to subscribe to this blog and receive notifications of new posts by email.