May 7, 2021

Stock Options: A Primer

In Financial Planning, Tax Planning, Wealth Strategy

Vince Lee
Contributions from: Vince Lee, CFP®, CPA

May 7, 2021

Companies are always looking for relatively inexpensive ways to increase the odds of getting the best workforce to join them. In the Technology sector, these ‘inexpensive’ ways often translate into offering employees stock options as incentives that don’t hit their cash reserves but offer workers an interesting ‘carrot’ – ownership in the company in return for their tenure and a job well done.  This works well for the companies that offer options in a few important ways.  It enables corporations to preserve cash, an often-finite asset needed to do business. Giving ownership to employees ties their wealth directly to the success of the company. And perhaps the most interesting, options have been marketed well with stories of average workers hitting IPO jackpots, tempting workers to take on the risk of a startup – especially with pre-IPO companies.

All great things for the company.  But what exactly do stock option plans mean to the employees? These option plans are often confusing, can happen over a long timeline, and if an employee is new to the stock option game, there is risk to their financial portfolio that isn’t as obvious as whether the company sinks or swims. Employees can start mitigating their personal financial risk by learning more about the various stock options offered by companies. I’ve put together a primer, outlining the different types of stock options, how they work, and ways investors can leverage these benefits over the long-term.

Stock Option Types – The Big Three

Restricted Stock Units (RSU)

A restricted stock plan is a stock grant a company gives employees, with restrictions or limitations applied.  For example, a common restriction requires the employee to forfeit the shares if the employee terminates employment within a certain number of years.  Often, the stock grants are transferred at no cost – these are a gift or bonus to the employee, and not something the employee needs to purchase.  When restricted stock is transferred, the employee’s income is not recognized until it vests.  Once the stock is vested (restrictions lapse), the employee recognizes ordinary income equal to the stock’s value less any amount paid for the stock and the stock is transferred to his/her name.  The tax burden on this type of taxable income can be as high as 39% depending your personal tax bracket plus state income tax.  RSUs are a great way to provide key employees with some kind of ownership without handing over immediate and unrestricted ownership.

Non-qualified Stock Options (NSO)

NSO stock options have a set purchase price, which doesn’t change regardless of what the stock is doing in the market. This can be risky from an employee perspective, because if the stock underperforms, their ‘benefit’ could be more expensive than purchasing the same shares on the regular market.  Fortunately, stock options usually last for a long period of time and the employee does not have to sell or buy the stock if it does not make sense economically.   It also could have tax implications if the stock performs well, as the employee will be taxed on the delta between the value of the stock and the “strike” or set purchase price when an exercise is made.  NSOs are taxed as regular income.

Incentive Stock Options (ISO)

ISOs are handled a bit differently from the other two option types.  These are given preferential income tax treatment, which may change the way an employee holds or sells these types of options.  These also come with a vesting schedule and strike price.  There are different work arounds for employees to help with the concentration risk large stockholders could be acquiring with their vesting schedule.  For optimal tax treatment, these have a required holding period of one year from date of exercise and two years from the date the option is granted.  These are also usually taxed differently, at the capital gains rate instead of the higher income rate. Generally, these stock awards are only for the C-level or director level/highly valued employees.

These, at a high level, are the different types of stock option plans available to employees. In my next article, I will outline the different ways employees can mitigate tax, concentration and cash-flow risk when exercising their benefits. My colleague Hilary Clark recently wrote a piece about how to avoid 10B5-1 complications around vesting and exercising schedules for C-level employees, which pairs well with this discussion around stock option considerations and benefits.  And as always, if you want to sit down to discuss your unique situation, benefits schedule or full financial portfolio, we are here to help. Contact me today at

Vince Lee | Relationship Manager & Wealth Planner
Vince can be contacted at (425) 283-1601,

CIRCULAR 230 NOTICE: Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any federal tax advice contained in this communication (including attachments) is not intended or written to be used and cannot be used for (1) avoiding penalties imposed under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any transaction or matter addressed herein unless the communication contains explicit language that it is a tax opinion in compliance with IRS requirements. Please contact your tax advisor for guidance on your individual situation.

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