Equity Compensation

Equity Compensation

Core Concepts

Restricted Stock Units (RSUs)

RSUs are a promise of shares delivered at vesting. There is no election to make and no exercise decision:

• Taxation: Full FMV of shares at vest is ordinary income (W-2 wages), subject to income tax, Social Security (up to the wage base), and Medicare. Cost basis = FMV at vest; holding period starts at vest.
• Withholding shortfall trap: Employers withhold federal tax on RSU income at the flat supplemental wage rate — 22% on supplemental wages up to $1 million cumulative for the year, with a mandatory 37% rate on the excess above $1 million (rates as of 2026, tied to statutory brackets — verify current). A client whose actual marginal rate is 32-37% is systematically under-withheld and can face a large April balance due plus underpayment penalties. Plan estimated payments or extra withholding in vest years.
• Post-vest decision: Holding vested RSU shares is economically identical to buying employer stock with a cash bonus. The default recommendation is sell-at-vest unless there is a deliberate concentration thesis; there is no tax benefit to holding beyond starting the capital gains clock.

Nonqualified Stock Options (NSOs)

• At exercise: Spread (FMV − strike) × shares is ordinary income (W-2 for employees), with payroll tax and withholding. Basis = FMV at exercise; subsequent gain/loss is capital.
• No AMT preference — NSO taxation is entirely in the regular system.
• Exercise timing is a bet on rate arbitrage and appreciation: early exercise moves future appreciation from ordinary income to capital gains but accelerates tax and concentrates risk.

Incentive Stock Options (ISOs)

• At exercise: No regular-tax income. The spread (FMV − strike) × shares is an AMT preference item in the exercise year (unless the shares are sold in a disqualifying disposition in that same calendar year, which eliminates the AMT adjustment).
• Qualifying disposition: Sale more than 2 years from grant AND more than 1 year from exercise. Entire gain over strike is long-term capital gain.
• Disqualifying disposition: Either holding test fails. Spread at exercise (capped at actual gain if the stock declined) becomes ordinary income in the year of sale; any gain above FMV-at-exercise is capital gain (short- or long-term by holding period from exercise). No payroll tax on the ordinary portion.
• $100,000 ISO limit: Aggregate grant-date FMV of ISOs first exercisable in any calendar year cannot exceed $100,000 (IRC 422(d)). This is a statutory figure and is NOT inflation-indexed. The excess is treated as NSOs.
• ISOs must be exercised within 3 months of termination (12 months for disability) to retain ISO status.

The AMT Mechanism and AMT Credit

The alternative minimum tax is a parallel tax computation. Simplified flow:

1. Start with regular taxable income, add back preference/adjustment items (the ISO spread is the dominant one for equity-comp clients) to get AMTI.
2. Subtract the AMT exemption — an inflation-indexed amount (in the low-to-mid $130,000s for MFJ as of recent years — verify the current figure) that phases out above a high AMTI threshold (thresholds and phaseout rate were changed by 2025 tax legislation effective 2026 — verify current parameters before advising).
3. Apply the two AMT rates: 26% up to an indexed breakpoint (roughly the low $200,000s of AMT base — verify current) and 28% above it, giving the tentative minimum tax (TMT).
4. AMT due = max(0, TMT − regular tax). The client pays the higher of the two systems.

AMT credit: AMT paid on deferral items (like the ISO spread) generates a minimum tax credit carried forward indefinitely, usable in future years when regular tax exceeds TMT. The ISO AMT is largely a prepayment, not a permanent cost — but the credit can take many years to recover. Shares exercised also get a higher AMT basis (FMV at exercise), so a later qualifying sale produces a smaller AMT gain, helping unlock the credit.

Planning levers: Exercise early in the year (option to disqualify before Dec 31 if the stock collapses — the classic dot-com trap was owing AMT on vanished paper gains); exercise only up to the "AMT crossover" amount where TMT just equals regular tax; spread exercises across years.

83(b) Elections (Restricted Stock, Not RSUs)

For restricted stock (including early-exercised options), Section 83(b) lets the holder elect to be taxed at grant/early-exercise on (FMV − price paid) rather than at vesting:

• 30-day deadline from the transfer date — statutory, no extensions. File with the IRS and give a copy to the employer.
• Converts all post-grant appreciation to capital gain and starts the holding period immediately. Most valuable when current spread is near zero (founder stock, early exercise at strike = FMV).
• Risk: Tax paid is not refundable if the shares are later forfeited; no deduction for the forfeited income (only a capital loss for actual amounts paid).
• RSUs are not eligible — there is no property transferred at grant.

Employee Stock Purchase Plans (ESPP, Section 423)

• Qualified plans allow purchase at up to a 15% discount, often with a lookback applying the discount to the lower of the offering-date or purchase-date price. Statutory cap: $25,000 per year of stock (valued at offering-date FMV) — IRC 423(b)(8), not indexed.
• Qualifying disposition (>2 years from offering date and >1 year from purchase): ordinary income = the lesser of (a) actual gain and (b) the discount computed on the offering-date price; the rest is long-term capital gain. With a lookback and an appreciated stock, this often converts most of the gain to LTCG.
• Disqualifying disposition: ordinary income = FMV at purchase − purchase price (the full bargain element, even if later sold at a loss); remainder is capital gain/loss.
• A 15% discount with a 6-month purchase period is roughly a 15/85 ≈ 17.6% return over ≤6 months even selling immediately — max participation with immediate sale is the low-risk baseline recommendation; holding for qualifying treatment adds concentration risk for a modest tax benefit.

Concentrated Stock Management

A single position above roughly 10% of net worth warrants a plan. Tools, in rough order of simplicity:

• Staged diversification: Preset sell schedule (e.g., equal tranches quarterly over 1-3 years) removes timing regret and market-timing behavior; coordinate lots (highest basis first) and gain budgets with the tax plan; insiders execute via a 10b5-1 plan.
• Charitable strategies: Donate long-term appreciated shares directly (or to a donor-advised fund) — full FMV deduction and the embedded gain is never taxed. Charitable remainder trusts (CRTs) allow diversification inside the trust with tax deferral and an income stream.
• Exchange funds: Contribute the concentrated position to a partnership pooling many investors' stocks; receive diversified units without a current sale. Requires a 7-year holding period for tax-deferred treatment (redemption in kind carries over basis); funds must hold at least 20% in qualifying illiquid assets; expect fees, lockup, limited control, and accreditation requirements.
• Protective collars: Buy a put, sell a call (often zero-premium). Caps downside without a sale. Watch: a collar that is too tight risks constructive-sale treatment under IRC 1259 (no bright line; meaningful band retained in practice); straddle rules can suspend the holding period and defer losses; a protective put on stock not yet held long-term restarts/suspends the LTCG clock. Collared stock supports high loan-to-value margin borrowing for diversification or liquidity ("collar and loan").
• Completion strategies: Build the rest of the portfolio to underweight the employer's sector so total exposure is closer to market weight.

Rule 10b5-1 Plans and Section 16 (High Level)

• A Rule 10b5-1 plan is a written trading plan adopted while not in possession of MNPI, giving an affirmative defense to insider-trading liability for trades executed later under its formula.
• 2022 SEC amendments (effective February 2023): Mandatory cooling-off periods before the first trade — for directors and officers, the later of 90 days after adoption/modification or 2 business days after filing the 10-Q/10-K covering the adoption quarter, capped at 120 days; for other insiders, 30 days. Also: good-faith condition, director/officer certification, a general bar on overlapping plans, one single-trade plan per 12 months, and quarterly issuer disclosure of plan adoptions/terminations.
• Section 16 (directors, officers, >10% holders): Form 4 within 2 business days of transactions; short-swing profit recapture under 16(b) on matched purchases and sales within 6 months (this can trap ESPP/option activity paired with open-market sales). Affiliates selling in the open market are also subject to Rule 144 volume limits and Form 144 filings. Coordinate every diversification plan with company counsel and the insider-trading policy's window periods.