Stock Options vs Restricted Stock Units (RSUs): A guide

There are a variety of types of equity compensation available to choose from when it comes to rewarding and incentivizing employees, two of which are Restricted Stock Units (RSUs) and Stock Options. In this post, we’ll discuss:

• What are stock options?
• What are restricted stock units?
• 4 key differences between stock options and restricted stock units
• Which is better?
• Summary: Stock Options vs. RSUs

What are stock options?

With stock options (generally referred to employee stock options), the company gives an employee the right to buy company stock at a predetermined price at a future date. That price is called the exercise price or strike price. In the US, that price is typically set at the fair market value (FMV) of the underlying stock as of the date the stock option is granted.

Stock options are often subject to vesting, meaning you don’t have full ownership of an asset until you’ve met the (time-based or milestone-based) requirements. Once it has passed, your stock options become exercisable for purchase. You can then sell the shares right away or hold onto them. One of their benefits is to allow you to buy your company stocks for a lower price and sell them at a higher FMV if the price of your company stocks grows over time.

Generally, there are two types of stock options: incentive stock options (ISOs) and non-qualified stock options (NSOs). While they operate in a similar way, they have some key differences (Check out the ‘’ISO vs. NSO’’ guide):

• ISOs: They can only be granted to employees. ISO-holders may qualify for preferential tax treatment (only pay capital gains taxes – CGT at sale) if they meet a certain set of criteria.
• NSOs: They can be granted to employees, contractors, vendors, directors, etc. However, NSO holders will need to pay ordinary income tax on the NSO spread when they exercise the options.

Typical Life Cycle: Grant ➜ Vesting ➜ Exercise ➜ Sale

What are restricted stock units (RSUs)?

RSUs are a type of restricted stock. At the grant date, you’re promised to receive the company shares or the cash equivalent (depending on your plan rules) in the future once the restriction period (i.e. vesting period) has passed. RSUs can vest either when certain performance goals are achieved or a set tenure with the employer is complete.

Once that period has passed, you will receive the vested RSUs and need to pay tax at this time. The shares can then be sold or kept. Unlike stock options, RSUs typically don’t require payment from employees, meaning no exercise is involved in its life cycle.

Typical Life Cycle: Grant ➜ Vesting ➜ Receive shares ➜ Sale

What’s the difference between Stock Options and RSUs?

While they both are common long-term incentive awards to motivate employees to improve company’s value over time, it’s important to be aware that there are very specific differences too:

• The value of the shares
• The need to pay for the stock
• Tax treatment
• The ability to time the tax

Difference 1: The value of the shares

The value of stock options depends on stock price appreciation above the exercise price, whereas RSUs are full-value awards based on the value of company stock. 

That means RSUs always have some value as long as the FMV of the stock is above zero. However, stock options will be worth nothing if the FMV of the stock falls below the strike price.

Difference 2: The need to pay for the stock

With an RSU, you’re granted the actual stock without having to pay anything.
With Stock Options, you have the right to buy a certain number of shares of stock at the pre-set price. (i.e. the stock is not free).

Difference 3: Tax treatment

Once RSUs are vested, they become taxable automatically. The FMV at vesting is subject to income tax and payroll taxes. Deductions would normally be processed through payroll with the employer withholding a portion of the RSU to pay any taxes. Long-term CGT (i.e. Sale price – FMV at vesting) is charged at sale if you hold your shares for a certain period of time.*

With NSOs, you need to pay ordinary income tax on the NSO spread at exercise (i.e. FMV at exercise – exercise price). When you sell your stock, gains (i.e. Sale price – exercise price – NSO spread) are taxed as long-term capital gain if the holding requirement* is met. If not, the gain is considered a short-term capital gain.

With ISOs, no income is recognized for the regular tax at exercise but you may have to pay an Alternative Minimum Tax (AMT). If you satisfy the holding period requirement*, you only have to pay long-term CGT at sale.

The rates for long-term CGT ranging from 0% to 20% are lower than regular income tax rates. If the holding requirement can’t be met, you’ll have a short-term capital gain which is taxed as ordinary income.

Holding Requirement:
*ISOs: Hold the stock for at least two years after the grant date and at least one year after exercising it.
*NSOs: Hold the stock for at least one year after exercising it
*RSUs: Hold the stock for over a year after they vest

Difference 4: The ability to time the tax

Employees have no control over the timing of their tax obligation with RSUs as they do with stock options because RSUs are always taxed after the vesting date. Having a choice on tax events is important for financial management because tax events can be spread out over a few — potentially lower tax — years to reduce your financial burden.

With stock options, employees can control when to exercise their options meaning they have a choice on the tax event. For example, with NSOs, if you have a higher income tax rate this year due to many income sources, you might reconsider the timing for exercising your options which could trigger a tax event.

Stock Options or RSUs: Which Is Better?

These two forms of stock compensation have their pros and cons. Stock options may be riskier than RSUs, but options allow you to time the tax while RSUs don’t. When deciding which suits you best, consider your company’s stage of growth and tax implications.

Stock Options are common among startups, especially in the tech industry, since these companies are more likely to see fast growth at the outset. They’ll allow the holder to buy low and sell high if the company is performing well and its stock price grows. 

Although the financial gain could potentially be substantial, there is no guarantee your company’s stock price will grow over time, meaning your options could potentially expire worthless. If you’re granted ISO, you’ll need to pay extra attention to AMT. Talk to your financial advisor to understand its potential consequences.

RSUs are often best suited to established companies where stocks may already be highly priced. Imagine if you were granted stock options in a mature company, the FMV of the common stock would be too high to motivate you to purchase them. RSUs are also typically offered after a private company goes public as part of an executive or senior management remuneration package and will be contingent on performance-related benchmarks being met. 

While RSUs are less risky without having to pay for the stock, you’re taxed once the vesting period has passed. So, if you don’t plan ahead, you may not have enough cash to pay off the tax bill.

Summary: Stock Options vs. RSUs

Regardless of whether it’s Restricted Stock Units, Stock Options or some other form of employee equity awards, we help companies every day to plan their perfect employee compensation strategy. Equity Compensation, Simplified – it’s what we do.

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JPMorgan Chase & Co., its affiliates, and employees do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal and accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any financial transaction.