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Equity Compensation Taxes 101, Episode 15

On this week's episode, we're going to talk about one of the most essential components of equity compensation. Actually, it is one of the most important parts of any successful investing strategy... taxes. Who doesn't love talking about taxes? I have a mantra when it comes to investments and taxes— it's not what you make, it's what you keep— this is critical because if you lose a good portion of your investment returns to taxes every year you lose some of the effectiveness of compounding over time. None of us has complete control over our taxes. However, there are some things we can control, and today I'm going to cover some of the basics.


You will want to hear this episode if you are interested in...

  • Common offerings you may have available to you [0:22]

  • Compensation income vs capital gains [4:52]

  • Differences in restricted stock [6:56]

  • 83b election [10:51]

  • Taxes on employee stock purchase plans [12:07]

  • This week’s FLASHBACK [15:31] 

The main components of equity compensation

The most common equity compensation options I deal with are non-qualified stock options usually called NSOs, restricted stock units referred to as RSUs, and restricted stock, which can sometimes be called restricted stock awards or even restricted stock grants. Finally, employee stock purchase plans known as ESPPs, although no one actually calls them that. These are the big types of equity compensation that I see in my world. So that's where I'm going to spend our time today. Be sure to check out the episode I’ve got a lot of info for you!

Compensation income and capital gains from NSOs

These are some phrases you should get familiar with. When you exercise your options you have to report income equal to the bargain element of the option at the time you exercise. This means if you pay $11,000 to exercise a non-qualified stock option for stock that is worth $15,000, you will report an income of $4,000. The income amount is fixed on the date that you exercise the option even if you continue to hold the shares. 

Now, let's talk about capital gains with NSOs. The general capital gain rule is that if you've held an investment for at least one year and a day, you pay taxes at a capital gains rate, which should be lower than your compensation income rate. Capital gains come into play with NSOs if you hold onto the shares after you've exercised them then sell them for a higher price later. Think of the example I mentioned before when you exercise the options at $11,000, and they were trading at $15,000, you then had a compensation income of $4,000. Now, let's say you held onto these exercised shares and they went up in price to a total value of $20,000. You now sell them for an additional gain of $5,000, which can be treated as capital gains. So the first tax bill comes when you exercise, it is for compensation income. The next one for capital gains comes when you actually sell the shares down the road Listen to the full episode for more details. 

This week’s FLASHBACK: Best summer job ever

If you don’t know Cedar Point is a very large amusement park. They call it the rollercoaster capital of the world. Working there was like going to college but never having to worry about studying. There were workers from all over the Great Lakes Area so I got to work with and meet people from Pennsylvania, Michigan, Indiana, Kentucky, and more. We worked long hours and didn't make much money, but we had a ton of fun, both on and off duty. I spent most of my time working on the train and we had a lot of fun there too. The official name of the train was the Cedar Point Lake Erie Railroad. If your college-age kid is considering working there I can't say it's the same type of job that it was when I worked there, but back then it was the best summer job I ever had.

I’m Dan Johnson, CFP®, founder of Forward Thinking Wealth Management. I run a flat-fee financial planning and investment management firm located in beautiful Akron, OH. Although I am in Akron, OH, I work with clients regardless of location. I cater to owners of equity compensation positions who are looking to organize their financial lives, keep more of what they make, and do the things they want in retirement and even now.