Knowing What Counts Podcast

Maximizing Your Stock Compensation Benefits with Expert Insights from Matt Baran

• Tim Provost, CPA • Episode 5

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What Are The Different Types Of Stock Compensation, And How Can Employees Maximize The Benefits While Navigating The Tax Implications And Potential Risks?

Discover how understanding the intricate world of incentive stock options, non-qualified stock options, restricted stock units, and employee stock purchase plans can make a significant impact on your financial future. Matt Baran, tax manager at MP CPAs, walks us through crucial dates like grant, vesting, and exercise, making the complex timeline of stock compensation much clearer. We delve into the tax advantages of incentive stock options, including how they interact with the alternative minimum tax and capital gains rates, and unravel the straightforward tax treatment of RSUs.

We explore the strategic art of accelerating income with the 83(b) election, a tool that may reduce your tax burden when leveraged effectively. Matt emphasizes the importance of weighing tax implications and non-tax considerations, such as company performance and portfolio diversification when making stock compensation decisions. Expert advice from Matt encourages listeners to consult with a tax advisor to navigate these challenging waters. Tune in for an episode packed with actionable insights to optimize your stock compensation strategy and secure your financial future.

To learn more about MP CPAs visit:
https://thempgroupcpa.com/
MP CPAs
413-739-1800

Speaker 1:

Welcome to the Knowing what Counts podcast, the place where expert guidance meets smart financial decisions. Whether you're a high net worth individual or a thriving business, the experts at MPCPAs are here to help you protect and optimize your wealth. Let's get started, because success begins with knowing what counts.

Speaker 2:

Stock compensation can be a game changer for employees, but it's not always as straightforward as it seems. Tax manager Matt Barron explains how to make the most of your shares while sidestepping tax traps and potential pitfalls. Welcome back everyone. I'm Sophia Yvette, co-host, slash producer, back in the studio with Matt Barron, tax manager at MPCPAs. So, matt, how's it going? Great?

Speaker 3:

How are you Sophia? I'm great. How are you, sophia?

Speaker 2:

I'm great. So, matt, what is equity compensation and what are the benefits to companies and employees alike?

Speaker 3:

Yep. So equity compensation is when a company provides stock in exchange for either services or capital. So generally it's another form of compensation in addition to your salary or bonus or things like that.

Speaker 2:

So, matt, what are the most common types of stock compensation?

Speaker 3:

The most common types of stock compensation are stock options. So those are incentive stock options, also called ISOs. There's non-qualified stock options, also called NSOs, and then there's RSUs, which are restricted stock units, and there's also employee stock purchase plans, which we'll touch on all of those a little bit today.

Speaker 2:

What about some key dates regarding stock compensation?

Speaker 3:

Yep. So some key dates are the grant date, which is when the employee is granted a right to either purchase the shares or to receive the share. So, in the case of options, the grant date is when they receive the right to purchase. If, for RSUs, it's when they receive the right to receive the share sometime down the road. There's also the vesting date, which is when the employee actually receives the shares. In terms of the restricted stock units, there will be a vesting schedule spread out over likely five years, and then they'll receive the shares evenly in a five-year span. And then there's also an exercise date which relates to stock options. So that's when you actually purchase a share, so that's when you'll actually receive them.

Speaker 2:

What are stock options exactly and how do they work?

Speaker 3:

Yep. So stock options give employees a right to purchase shares at a given point in time and at a set price. So there's two type of stock options incentive stock options and non-qualified stock options. So the taxation on those is a little bit different.

Speaker 2:

What is the biggest difference in the taxation on those?

Speaker 3:

So incentive stock options are generally more beneficial for the employee, so they are. When they're exercised, there's what's called an AMT preference item, so they are subject to alternative minimum tax. However, that is reversible in a future year whenever you are not subject to alternative minimum tax. So that's kind of just a timing difference, but there is that tax aspect to it. And then, once you exercise the shares, there's a holding period. So you have to hold the shares for two years from the grant date or one year from the exercise date in order to qualify for the capital gain tax rates.

Speaker 3:

So, generally speaking, that's why incentive stock options are most beneficial, because there is an upfront tax of the. But Down the road, as long as you pulled it for that required period, you will, you'll, one, reverse the AMT tax and then, two, you'll get the capital gain. So if you do not reach the holding period requirements, that'll be taxes, ordinary income that's called a disqualifying disposition, and then for non-qualified stock options, so those are taxed as ordinary rates when they are exercised. They are exercised so the difference of the set price at the grant date versus the fair market value when you purchase the shares, that's called the spread and you're taxed at ordinary rates on that spread, and then your holding period begins for the capital gain rates from there.

Speaker 2:

So, matt, what are the RSUs and how are they different from stock options?

Speaker 3:

RSUs are when employees are granted stock over certain vesting periods. So that could either be a length of time or performance metrics that you need to hit. But so what makes them different from options are you actually receive the right to the shares themselves sometime down the road, rather than just the right to purchase them. So RSUs are not typically. You're not paying any money out of pocket for them, and then those are taxed at ordinary rates, same as like your W-2, when you receive them. So it's taxed as the fair market value of the stock on the vesting date and then from there your holding period begins and then, if you reach those that one year hurdle, then it upon a sale, it becomes capital gains what about employee stock purchase plans?

Speaker 2:

what are they and what are the tax implications?

Speaker 3:

yep, yep. So employee stock purchase plans allow employees to purchase stock at a discounted price. So if your employees are offered the right to purchase shares at $10 when the fair market value is $12. So they still are paying that out-of-pocket cost. However, they are receiving a benefit of that discount and then, very similar to ISOs, they have the same holding periods. So you need to hold it for two years after the offer date and then one year after the actual purchase date and then those will qualify for capital gains tax rates as well. Those will qualify for capital gains tax rates as well.

Speaker 2:

So, matt, how does an 83B election fit in with all of this?

Speaker 3:

So 83B elections are probably most typical for startups. What they are? It's an election to accelerate income from the entire vest. Of restricted stock awards, for example, you will be paid out over a vesting schedule, but you can make this 83b election in order to elect to accelerate all that income of the fair market value over the total vesting period into the current year.

Speaker 3:

So that's why it's most typical with startups, because right when a company starts out, their fair market value of their stock is generally going to be zero or very little. So you can kind of take that hit of the ordinary income in the current period. And the benefit of that is two things you don't get taxed on the ordinary income as those vests over the years, and that also opens up the capital gain holding period as well for when you eventually sell the stock down the line. So whatever ordinary income you accelerate into the current year, that is your basis. Oftentimes it's zero. It could be whatever you pick up as income that year and then sometime down the road, that's your basis when you sell the stock.

Speaker 2:

What about key considerations for employees managing their equity compensation? What are those key considerations?

Speaker 3:

There's definitely a few things to think about. Timing is probably the most important factor. Depending on which stock compensation you're receiving, the timing is going to vary. So, like I mentioned the incentive stock options, you want to be aware of that large tax bill that would come with the AMT preference item. You also, for all of them, you want to be aware of the holding periods so you are able to benefit from the long-term capital gain rate versus risking any disqualifying dispositions and being taxed at higher rates. You also want to consider any outside income that you might have. If you already typically have high ordinary income, whether that's from a spouse's job or another method, then you want to consider that when you're accelerating some income, like in the example of an 83B election, if there actually is income that you're accelerating into the current year.

Speaker 3:

You want to consider that as well, because you don't want to be taxed at the highest rates possible. And then, just yeah, the various tax considerations of the ordinary versus capital gains. And then there's also the non-tax considerations of do you believe in the long-term future of the company, do you want to be kind of over-invested in it, or do you want to maybe diversify a little bit more, and that would also maybe lead you to sell some shares that you receive. So those are all things to consider, lead you to sell some shares that you receive. So those are all things to consider and, as always, it's best to consult a tax advisor.

Speaker 2:

Well, Matt, we'll catch you in the next episode.

Speaker 1:

Have a fantastic rest of your day, thank you. You, too, thanks for listening to the Knowing what Counts podcast. Ready to optimize your wealth and protect your future, visit thempgroupcpacom or call 413-739-1800 to connect with our team of experts. Remember, success is about knowing what counts.