ESPP vs RSU: Understanding Employee Stock Plans

Let's dive into the world of employee stock plans, where ESPPs and RSUs often get confused with each other. An ESPP, or Employee Stock Purchase Plan, allows employees to buy company stock at a discounted price, typically 85% of market value.

Employees can purchase company stock through payroll deductions, and the amount they can buy is usually capped. For example, if an employee contributes 10% of their salary to the ESPP, they can buy up to 10% of the company's stock at the discounted price.

RSUs, or Restricted Stock Units, are a type of equity award that vests over time, meaning employees must wait a certain period before they can receive the stock. The good news is that RSUs are taxed at the lower capital gains rate, which can result in significant tax savings.

RSUs can be a great way for employees to build wealth over time, especially if the company's stock price appreciates.

An employee stock purchase plan (ESPP) allows employees to buy company stock at a discounted price, typically through payroll deductions that build up between the offering date and the purchase date.

The discount rate on company shares can be as much as 15% lower than the market price, making it a potentially valuable benefit for employees.

With an ESPP, the company uses the employee's accumulated funds to purchase stock on their behalf at the purchase date.

Employees can make a profit if the company grows and becomes more successful, causing the stock to become more valuable.

To be eligible for an ESPP, you typically need to have been employed by the company for at least one year. Employees who own more than 5% of company stock are usually not allowed to participate.

Other employees, however, have the option to participate in the plan. They're not required to, but it's available to them. This is a common practice among companies offering ESPPs.

Eligibility rules for ESPPs are in place to ensure fairness and equity among employees.

Typically, employees who own more than 5% of company stock are not allowed to participate in ESPPs.

Restrictions often require employees to have been employed with the company for a specified duration, usually one year, before they can join the plan.

All other employees are generally eligible to participate in the plan, but participation is not mandatory.

An ESPP can be either qualified or non-qualified, each with its own set of rules and benefits.

Qualified ESPPs require shareholder approval and have restrictions on the maximum price discount allowable. They also have to follow IRS Section 423 regulations.

Non-qualified ESPPs, on the other hand, are not subject to as many restrictions as qualified plans, but they don't have the same tax advantages.

A qualified ESPP is designed to promote employee ownership and retention, just like a non-qualified plan. However, a non-qualified plan offers more flexibility in plan design.

Here are some key differences between qualified and non-qualified ESPPs:

About 79% of ESPPs in the US are qualified, but non-qualified plans can be attractive to companies with a large population of non-US employees.

Employee stock purchase plans (ESPPs) are a type of employee benefit that allows employees to purchase company stock at a discounted price. This discount can be as much as 15% lower than the market price.

Employees contribute to the plan through payroll deductions, which build up between the offering date and the purchase date. The company then uses these accumulated funds to purchase stock on behalf of the participating employees.

A key feature of ESPPs is the "look back" provision, which allows the plan to use a historical closing price of the stock. This price is often the lower of the offering date or purchase date.

By participating in an ESPP, employees can potentially make a profit as the company grows and becomes more successful, causing the stock value to increase.

Taxes can be complex, but let's break it down. ESPPs are taxed as ordinary income or as a deductible loss, depending on the sale of the stock. The difference between the original stock price and the sale price is considered a capital gain or loss.

The taxation rules for ESPPs can be tricky, but it's essential to understand them. If you sell the stock within one year of receiving it or two years of the option being granted, the entire gain is taxed as ordinary income.

Restricted stock, on the other hand, is taxed differently. The entire amount of vested stock is reported as ordinary income in the year of vesting. This can be a significant tax burden, as seen in the example of Sam, who had to report $900,000 of ordinary income when the stock became fully vested.

RSUs have a simpler taxation process. The value of the stock is reported as ordinary income in the year it becomes vested, with no Section 83(b) election permitted. This means there's only one date to declare the value of the stock.

Here's a comparison of the taxation rules for ESPPs and RSUs:

The Section 83(b) election can also affect taxation. By electing to report the fair market value of the shares as ordinary income at the time of grant, restricted stockholders can potentially reduce their taxes. This election is especially beneficial when there's a longer time frame between the grant and vesting dates.

Taxes on employee stock purchase plans (ESPPs) can be complex, but in general, you'll be taxed on any stock you purchase through an ESPP during the year you sell it.

The difference between what you paid for the stock and what you received when you sell it is considered a capital gain or loss. Any discount offered to the original stock price is taxed as ordinary income, while the remaining gain is taxed as a long-term capital gain.

If you sell stock purchased through your ESPP more than 12 months after you purchased it, any gain beyond the discount that you received through the plan is taxed as a capital gain. The discount is taxed as ordinary income.

There are two types of ESPPs: qualified and non-qualified. A qualified ESPP is designed and operates according to Internal Revenue Section (IRS) 423 regulations, and it's treated more favorably on taxation. A non-qualified ESPP does not meet IRS criteria and has a less favorable tax regime.

Here's a comparison of qualified and non-qualified ESPPs:

Restricted stock and RSUs are taxed differently from other stock options, such as ESPPs. Restricted stock usually becomes taxable upon the completion of the vesting schedule, while RSUs are taxed as ordinary income in the year of vesting.

The taxable amount for restricted stock is determined by subtracting the original purchase or exercise price of the stock (which may be zero) from the fair market value of the stock when it becomes fully vested. The difference is reported as ordinary income.

RSUs are a bit simpler to tax, as the value of the stock is reported as ordinary income in the year the stock becomes vested. There is no actual stock issued at grant, so no Section 83(b) election is permitted.

A qualifying disposition in an Employee Stock Purchase Plan (ESPP) occurs when you hold your shares for at least two years from the offering date and at least one year from the purchase date.

This means you'll pay taxes on the discount as ordinary income, and the rest of the gain will be taxed at the long-term capital gains rate, which is usually lower.

If you sell your shares right away, or hold them for less than two years from the offering date or less than one year from the purchase date, it's considered a disqualifying disposition.

In a disqualifying disposition, any gains are considered short-term and are taxed at a typically higher rate.

Here's a quick summary of the key differences between qualifying and disqualifying dispositions:

RSUs are similar to restricted stock options, but with some key differences. They're essentially a promise from your employer to grant you a set number of shares of stock once you've completed the vesting schedule.

You can't receive actual shares until the vesting and forfeiture conditions are met, which is different from restricted stock. RSU holders also have no voting rights during the vesting period because no shares have been issued yet.

Some RSU plans offer the option of a cash payout instead of stock, but most require actual shares to be issued.

Restricted Units are a type of compensation that resemble restricted stock options, but differ in some key respects.

RSUs represent an unsecured promise by the employer to grant a set number of shares of stock to the employee once the vesting schedule is completed.

Some RSU plans offer the option of a cash payout instead of stock, but most plans require that the actual shares be issued—though not until vesting and forfeiture conditions are met.

Unlike restricted stockholders, RSU holders have no voting rights during the vesting period, as no shares have been issued yet.

The rules of each plan determine whether RSU holders receive dividend equivalents.

RSUs are taxed differently from other stock options, such as statutory or non-statutory employee stock purchase plans (ESPPs).

Restricted stock usually becomes taxable upon the completion of the vesting schedule, whereas RSUs become taxable when the shares are actually issued.

The taxable amount is determined by subtracting the original purchase or exercise price of the stock (which may be zero) from the fair market value of the stock when it becomes fully vested.

The difference is reported as ordinary income.

If the stock is not sold at vesting, but later, any difference between the sale price and the fair market value at vesting is treated as a capital gain or loss.

In some cases, employees can decide when to receive their RSUs, which may be useful for tax planning.

Sam, a key executive, received restricted stock grants of 10,000 shares for zero dollars and decided to declare the stock at vesting.

Alex, another executive, elected for Section 83(b) treatment, which allowed him to report $200,000 as ordinary income.

Five years later, on the date the stock becomes fully vested, Sam will have to report a whopping $900,000 of the stock balance as ordinary income in the year of vesting.

Phantom Appreciation Rights can be a bit tricky to understand, but essentially they're a type of equity compensation that's based on the value of company stock.

These rights are often granted to employees in addition to restricted stock units or stock options, and they can be a great way to boost an employee's compensation package.

Phantom appreciation rights typically vest over a set period of time, similar to restricted stock units, and the value of the award is based on the increase in the company's stock price during that time.

As with restricted stock units, phantom appreciation rights can be subject to certain conditions, such as performance goals or service requirements.

The value of the phantom appreciation right is usually paid out in cash, and the amount is typically calculated based on the difference between the initial and final stock price.

In some cases, phantom appreciation rights may be granted as a substitute for restricted stock units or stock options, and they can provide a similar benefit to employees.

Phantom appreciation rights can be a valuable tool for companies looking to attract and retain top talent, and they can be a great way to reward employees for their hard work and dedication.