If you work for a private company that plans to eventually go public, a significant portion of your compensation may come in the form of equity. While it can be tempting to think of all equity compensation simply as company stock, equity compensation comes in many varieties, each with its own characteristics. Awareness of these distinctions can help you prepare for important decisions before and after a liquidity event, avoid unintended tax consequences and align your equity strategy with your broader wealth goals.
To make those decisions wisely, you should start by understanding exactly what type of equity awards you received. Four of the most common awards are non-qualified stock options (NQSOs), incentive stock options (ISOs), restricted stock units (RSUs) and performance stock units (PSUs). They differ in their vesting requirements, tax treatment and planning opportunities. (Exhibit 1)
Source: J.P. Morgan Private Bank
*Vesting terms and expiry conditions vary by plan and award agreement.
**The AMT is a parallel U.S. tax system that recalculates taxable income with fewer deductions and preferences to ensure certain taxpayers pay at least a minimum amount of tax. Upon exercise, the spread between the strike price and the FMV at the time of exercise generally is not subject to tax under the regular income tax system, but may be subject to tax under the AMT. Although ISO exercises can trigger AMT, taxpayers may be able to recover some or all of that AMT through future AMT credits, depending on their circumstances. You should consult with your tax advisors about your potential AMT exposure and other tax implications.
As a private company comes closer to an IPO, merger or acquisition, it’s natural for executives and employees to become increasingly focused on understanding their equity compensation and how it fits into their broader financial picture. Common questions address vesting schedules, the impact of double-trigger RSUs and tax-efficient strategies for diversifying concentrated positions. Many executives are also considering how their equity holdings can support family, estate and charitable planning objectives.
ISOs and NQSOs deserve special attention. ISOs in particular often require careful analysis because of the interaction between vesting schedules, future liquidity events and the alternative minimum tax (AMT). A more detailed discussion of stock option planning can be found here.
If you believe your company’s value could increase significantly over time, the exercise of options while valuations are relatively modest may create planning opportunities. However, the benefits and risks of any exercise strategy depend on an individual’s cash flow needs, tax situation, risk tolerance and outlook for the company. Even after an IPO, company insiders may remain subject to lock-up periods and trading restrictions that limit the timing of stock sales.
Your J.P. Morgan team can help you better understand the opportunities and intricacies of equity awards, and work with you to design a strategy that supports your long-term financial goals.
This material is intended to help you understand the financial consequences of the concepts and strategies discussed here in very general terms. The strategies discussed often involve complex tax and legal issues, and are not intended to provide, and should not be relied on, for tax, legal or accounting advice.
JPMorgan Chase & Co. and its affiliates and employees do not provide tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any financial transactions.
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