Table of Contents
- What Are Restricted Stock Units (RSUs)?
- How RSUs Differ From Stock Options
- RSUs vs. Stock Options — Quick Comparison
- Tax Treatment of RSUs and Stock Options
- Why Entrepreneurs Should Understand the Difference
What Are Restricted Stock Units (RSUs)?
A Restricted Stock Unit, or RSU, is a form of equity compensation in which a company grants an employee shares of company stock, subject to a vesting schedule. Vesting typically occurs over several years, and the shares become owned by the employee only once they vest. This structure is designed to encourage employees to remain with the company until their RSUs are fully vested.
How RSUs Differ From Stock Options
Both RSUs and stock options are common forms of stock-based compensation, but they differ in structure, value, and risk.
- RSUs are essentially a promise to deliver company shares, or their cash equivalent, after a set vesting period.
- Stock options give the employee the right, but not the obligation, to purchase company shares at a predetermined price (the “exercise price”) after vesting.
Because RSUs result in the delivery of shares if vesting conditions are met, they are generally considered less risky. The value of stock options, by contrast, depends on the market price exceeding the exercise price, if the market price is lower, the options can expire worthless.
RSUs vs. Stock Options — Quick Comparison
| Feature | RSUs | Stock Options |
| Ownership | Not immediate | Not immediate |
| Grant | Promise of shares | Right to purchase shares |
| Value | Equal to stock price upon vesting | Difference between market price and exercise price |
| Cost | Typically no cost upon vesting | Must pay the exercise price to acquire shares |
| Risk | Lower, shares (or cash) delivered if vested | Higher, no value if market price stays below exercise price |
Read also: What is the Qualified Small Business Stock Exclusion?
Tax Treatment of RSUs and Stock Options
RSU Taxation
RSUs are typically taxed as ordinary income when they vest, based on the fair market value of the shares at that time. If the shares are later sold, any change in value after vesting is taxed as a capital gain or loss. RSUs generally cannot be taxed earlier unless they are structured as restricted stock and an 83(b) election is filed.
Stock Option Taxation
Stock option taxation depends on the type of option:
- Incentive Stock Options (ISOs), generally not taxed upon exercise if certain holding requirements are met, but the “spread” (market price minus exercise price) may trigger alternative minimum tax (AMT). Any gain upon sale is taxed at long-term capital gains rates if holding periods are met.
- Nonqualified Stock Options (NSOs), taxed as ordinary income at exercise on the spread between the exercise price and market value. Any post-exercise appreciation is taxed as capital gain when the shares are sold.
Because the tax implications can be complex, especially for ISOs, it is wise for both employers and employees to consult with tax professionals before exercising or structuring equity grants.
Why Entrepreneurs Should Understand the Difference
For startups and growing companies, choosing the right form of equity compensation can have significant impacts on employee incentives, company cash flow, and long-term ownership structure. At Sutter Law, our business attorneys can help you determine whether RSUs, stock options, or another equity vehicle is best for your team, and prepare the agreements to match your business goals while ensuring compliance with tax and securities laws.
