Restricted Share Units vs. Stock Options

Equity compensation helps attract and retain top talent. For executives, Restricted Share Units (RSUs) and Stock Options are two common forms of equity. Both offer a path to ownership, but they differ in structure, taxation, and potential gains. This guide breaks down the differences, helping executives understand which option best aligns with their financial goals.

What Are Restricted Share Units (RSUs)?

RSUs are company shares granted to employees as part of compensation. The shares vest over a defined period, usually tied to continued employment or performance milestones. Once vested, RSUs convert to company stock, which the recipient can sell or hold.

Key Features of RSUs

• No Purchase Required – Executives do not need to buy the shares. The company grants them as part of compensation.
• Vesting Period – Shares vest over time or when someone meets specific goals.
• Taxation at Vesting – The IRS taxes RSUs as ordinary income when they vest, based on the stock’s fair market value.

Pros of RSUs

• Guaranteed Value – RSUs retain value even if the stock price declines.
• Predictable Income – RSUs offer a defined benefit, helping executives plan their financial future.
• Simplified Process – No need to purchase company stock or track strike prices.

Cons of RSUs

• Immediate Taxation – Taxes apply at vesting, even if the executive holds the shares.
• Limited Upside – Gains are tied to stock price growth after vesting.

What Are Stock Options?

Stock options give executives the right to buy company shares at a fixed price, known as the exercise price or strike price. Options usually vest over time, giving the holder flexibility on when to exercise them.

Key Features of Stock Options

• Purchase Required – Executives must buy the shares at the set price.
• Vesting Period – Similar to RSUs, options vest over time or after meeting goals.
• Taxation at Exercise – Taxes apply when the option is exercised, with potential capital gains taxed upon sale.

Types of Stock Options

1. Incentive Stock Options (ISOs) – Preferred for favorable tax treatment but subject to strict requirements.
2. Non-Qualified Stock Options (NSOs) – More flexible but taxed as ordinary income when exercised.

Pros of Stock Options

• High Upside Potential – If the stock price rises, options offer significant gains.
• Tax Timing Flexibility – Executives can control when they exercise options, managing tax implications.

Cons of Stock Options

• Risk of Expiry – Options can expire worthless if the stock price remains below the exercise price.
• Purchase Obligation – Executives must pay to acquire the shares, adding potential financial risk.

RSUs vs. Stock Options: Key Differences

1. Ownership and Control

• RSUs – Shares are granted automatically after vesting.
• Stock Options – Executives must choose to exercise options and buy shares.

2. Taxation

• RSUs – Taxed as ordinary income at vesting, regardless of sale.
• Stock Options – ISOs may qualify for favorable capital gains tax treatment, while NSOs are taxed at exercise.

3. Risk and Reward

• RSUs – Provide guaranteed value but limited upside after vesting.
• Stock Options – Offer higher potential gains but come with the risk of losing value.

4. Flexibility

• RSUs – Minimal control over timing, as taxation happens at vesting.
• Stock Options – Greater flexibility in deciding when to exercise, which can influence tax outcomes.

Tax Implications for Executives

RSU Taxation

• At Vesting – Record RSUs as ordinary income when shares vest. You can calculate the value based on the stock’s fair market price.
• Capital Gains – If the executive holds the shares and sells later at a higher price, any increase counts as capital gains in taxes.

Stock Option Taxation

• ISOs – If held for at least one year after exercise and two years from the grant date, ISOs qualify for long-term capital gains tax.
• NSOs – Taxed as ordinary income at exercise, with capital gains taxes applying if the stock appreciates after purchase.

Understanding Vesting Schedules and Periods

Both RSUs and stock options follow a vesting schedule. This schedule determines when the shares or options become available to the executive.

• Cliff Vesting – Shares or options vest all at once after a set period, typically one year.
• Graded Vesting – Shares or options vest gradually over a period, such as 25% per year over four years.

Importance of Tracking Vesting Periods

Executives should track vesting periods closely to avoid missing deadlines or losing valuable equity. Understanding the vesting schedule ensures that they know when to expect taxable income and when they can sell or hold vested RSUs or exercise stock options.

Equity Compensation and Long-Term Financial Planning

For executives, equity compensation serves as a tool to build long-term wealth. Both RSUs and stock options offer opportunities to increase net worth, but each requires careful planning to maximize value and minimize tax liabilities.

Building a Diversified Portfolio

Relying solely on company stock can expose executives to concentrated risk. Diversifying holdings reduces the risk associated with stock price fluctuations. After RSUs vest or stock options are exercised, executives should consider reinvesting proceeds into a mix of assets such as:

• Mutual funds
• Real estate
• Index funds

Timing Equity Sales to Manage Taxes

Executives can reduce tax burdens by strategically timing the sale of company shares. Selling vested RSUs or exercised stock options in a year with lower income can reduce the overall tax rate.

When to Choose RSUs

RSUs are ideal when:

• Executives prefer a predictable benefit with guaranteed value.
• Market volatility makes stock appreciation uncertain.
• They want to avoid the complexity of exercising options and managing strike prices.

When to Choose Stock Options

Stock options are better when:

• Executives expect the stock price to rise significantly.
• They seek greater control over timing to optimize tax outcomes.
• They are comfortable assuming the risk of the options expiring worthless.

Combining RSUs and Stock Options

Many companies offer a combination of RSUs and stock options to balance security and growth potential. This approach allows executives to benefit from guaranteed value while maintaining upside potential.

Granting Stock Options and RSUs – What Executives Should Know

When companies grant stock options and RSUs, they define the terms that influence future value. Understanding the grant terms ensures that executives make informed decisions about exercising options and managing vested RSUs. Key factors to consider include:

• Exercise Price – The fixed price at which stock options can be purchased.
• Vesting Period – The time before RSUs or stock options fully vest.
• Expiration Date – The deadline for exercising stock options.

Paying Taxes on RSUs and Stock Options

Paying taxes on RSUs and stock options depends on the timing of vesting and exercise. Executives should prepare for these tax implications:

• RSUs – Taxes apply when shares vest, typically as ordinary income.
• Stock Options – ISOs may offer favorable capital gains tax treatment, while NSOs incur taxes at exercise.

Maximizing Equity Compensation – Expert Tips

1. Understand Vesting Schedules – Know when shares or options become available.
2. Monitor Tax Implications – Plan for taxes at vesting or exercise to avoid unexpected liabilities.
3. Diversify Holdings – Avoid over-reliance on company stock by diversifying assets.
4. Consider Professional Guidance – Work with legal and financial experts to optimize your equity strategy.

How The Craighead Law Firm Can Help

Clayton Craighead has extensive experience advising executives on equity compensation, including RSUs and stock options. His background in accounting and business administration gives him a unique perspective on financial implications and tax planning. As a trusted Houston attorney, Clayton helps clients structure their compensation packages to maximize value while minimizing risk.

Know Your Options

RSUs and stock options each offer unique benefits for executives. RSUs provide predictable value, while stock options offer high upside potential. Understanding the differences helps executives make informed decisions and maximize long-term gains. Partnering with experienced professionals ensures that equity compensation aligns with career goals and financial strategies.