Stock Options 102

Stock options are another form of compensation that’s common when you work at a startup. You aren’t actually receiving the shares (yet), you are receiving the option to purchase the shares for a certain price in the future called the strike price, exercise price or grant price. If the value of the stock is higher than the strike price, then the difference is the money you’ve made or the discount at which you’re purchasing the shares. There are two types and there are different tax implications depending on which one you have.

  • Non-qualified stock options (NSOs). When you exercise your options (or buy shares), you will be taxed on the gain (the difference in the current value you and your exercise price) at the ordinary income tax rate.  

If you go on to sell the shares for a profit, you will pay capital gains tax on any profit you earned from after the time you purchased or exercised your options.

Employee Stock Purchase Plan (ESPP)

This typically will look like the opportunity to buy your company’s stock at a discount (sometimes a discount to the lowest stock price of the quarter). If you purchase stock at a 20% discount, you’ve already made a 20% return on day 0. Pretty amazing. When you are paid by your company and a large percent of your portfolio is invested in company stock, your financial life is very dependent on the company’s success. It’s often recommended to hold the stock for a year (so you don’t pay short-term capital gains tax) and then sell in order to invest in something more diversified. But if you are a huge believer in your company and you aren’t depending on those investments, you might also decide to keep some in company stock to stay along for the ride. 

Restricted Stock Units (RSUs)

A restricted stock unit (RSU) is compensation in the form of company shares. When the shares vest, they are considered income and a portion will be held to pay income taxes. Once you receive the shares, they are yours to hold or sell.