Restricted Stock & Incentive Stock Options Explained

Restricted Stock & Incentive Stock Options Explained

Incentive & Restricted Stock Explained

Oftentimes, employee compensation packages may include various types of stock options or stock awards. Some of the more common types of acronyms you will find include ISO (Incentive Stock Options); NSO (Non-Qualified Stock Options); RSU (Restricted Stock Units), and RSA (Restricted Stock Awards). While in general, these types of compensation packages can be very beneficial to employees — it is important to note that they are not all treated the same for US tax purposes. And while there is some overlap between the different types of awards options and units — let’s go through some of the basics of Incentive & Restricted Stock — and what the acronyms ISO, NSO, RSU, and RSA mean from a US tax perspectively — along with what happens when a foreign entity is involved.

ISO (Incentive Stock Options)

The ISO is an Incentive Stock Option is an “option” and therefore they require the employee to exercise the option in order for the ISO to take effect. As opposed to Non-Qualified Stock Options, the ISOs qualify for preferential tax treatment — namely, that tax is deferred until the shares are sold — and when they are sold they will generally qualify for long-term capital gains tax treatment (maximum tax rate of 20%) instead of ordinary income (maximum tax rate of 37%). Without getting too far into the complexities, the stock option grants the employee the opportunity to purchase stock directly from the company at a set price — and then there are vesting schedules that require the employee to wait a certain amount of time before they are allowed to exercise the option. As long as the employee holds the stock for sufficient time — taxes are essentially limited to long-term capital gain (LTCG).

NSO (Non-Qualified Stock Options)

Unlike the incentive stock options, a non-qualified stock option does not qualify for the same preferential tax treatment as an ISO. NSOs are generally treated as Ordinary Income (OI) and therefore the income is taxed at ordinary income rates — along with Social Security and Medicare tax. When the NSOs are sold, the basis will include the value of the shares and the amount of income when exercised. Basic Example: 1000 options are granted. If the strike price is $50 and Market Value is $85, then the cost is $50,000 plus the income, which equals $35 * 1000 = $35,000. But, the basis when it is being sold, the basis is usually = $85 per share – which represents the strike price, plus the FMV on the date of exercise (and you paid OI tax on the difference).

RSU (Restricted Stock Units)

A Restricted Stock Unit is a form of income or compensation for employees who remain at the company long enough for the stock to vest. Once the employee has reached the length of time necessary for the RSU to vest, the employee receives the shares as part of their compensation — and it is reported on the W-2.

RSA (Restricted Stock Awards)

Unlike the RSU, when an employee receives an RSA (Restricted Stock Award), they actually receive the award/shares at the outset – but they are “restricted” and cannot be sold until after the restriction period expires. Income tax is due when the stocks vests (OI)  and then capital gains tax when it is sold. Depending on the type of company and project growth/profitability, the RSAs may be ripe for 83(b) elections at the time of the award as opposed to the time it vests – which will reduce income tax but increase capital gains tax (better for the employee if the value goes up).

Foreign Reporting  of Restricted Awards, Units, and Options

When there is an international or foreign component to the company, it adds an extra layer of possible reporting and disclosure. Depending on how the shares or options are owned and the value associated with them can impact whether or not they are reportable to the IRS on various international information reporting forms such as FBAR and FATCA.

Failure to Report Foreign Incentive & Restricted Stock to IRS

If a US person has not properly reported their foreign stock for income tax or disclosure purposes, there are various offshore amnesty programs the taxpayer could apply to in order to see if we get into compliance. The FBAR/FATCA Amnesty Programs are programs developed by the Internal Revenue Service to assist Taxpayers who are already out of compliance for non-reporting. Some of the more common programs include:

Can I Just Start Filing FBAR This Year Instead?

No, unless the current year is the first year you had an FBAR Reporting requirement. If you had a prior year reporting requirement, but only begin to start filing in the current year (Filing Forward) it is illegal. In the world of offshore disclosure, this is referred to as an FBAR/FATCA Quiet Disclosure. The IRS has warned taxpayers that if they get caught in an FBAR/FATCA Quiet Disclosure situation, it may lead to willful penalties and even a criminal investigation by the IRS Special Agents.

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