Q2 2025 Wealth Strategy Insights
by Phillip Scavo, MBA, CFP® Wealth Planning Manager
Equity Compensation: A Simple Guide to ISOs, NSOs, and RSUs
Equity compensation provides an opportunity to build wealth by sharing in your company’s success. Common forms include Incentive Stock Options (ISOs), Non-Qualified Stock Options (NSOs), and Restricted Stock Units (RSUs). Each works differently, with unique tax implications, but all can help grow your savings if your company performs well. This guide breaks down how these types of equity compensation work— simply and clearly—so you can understand what they mean for you and your family.
What Is Equity Compensation?
Equity compensation means receiving ownership in a company as part of your pay. Instead of just a salary, you may get:
● The right to buy shares at a set price (stock options), or
● Actual shares delivered over time (RSUs).
Both public and private companies offer equity compensation, each with distinct considerations.
Common Incentive Types
Incentive Stock Options (ISOs): Allow employees to buy company stock at a fixed (often discounted) price with potential
tax advantages—if certain rules are followed.
Non-Qualified Stock Options (NSOs): Similar to ISOs but more flexible, available to employees, contractors, and
advisors. They follow simpler, but less favorable, tax rules.
Restricted Stock Units (RSUs): Promises to deliver company shares after certain conditions are met (e.g., staying for a
number of years). No upfront cost; simpler taxes.
Key Terms to Know
Exercise Price / Strike Price: The fixed price at which you can buy company stock via options.
Fair Market Value (FMV): The current value of the company’s stock, used for valuing equity awards and calculating
taxes.
Cliff: A period (often one year) before any portion of your equity vests.
409A Valuation: An independent valuation of a private company’s stock, required for setting exercise prices under IRS
rules.
Understanding ISOs, NSOs, and RSUs
Let’s break down how each type works with a simple example. Imagine your company’s stock is worth $20 per share
today.
Incentive Stock Options (ISOs)
You receive 1,000 ISOs with a $20 strike price. If the stock price rises to $50 in three years:
● You buy for $20,000 and sell for $50,000—a $30,000 gain.
● No tax is due when exercising, but Alternative Minimum Tax (AMT) may apply.
● To get favorable capital gains treatment, you must:
○Hold the shares one year after exercising, and
○ Two years after the grant date.
●Only employees are eligible for ISOs, and there's a $100,000 per year limit on ISOs you can exercise based on
FMV.
Non-Qualified Stock Options (NSOs)
You receive 1,000 NSOs at a $20 strike price. If the stock reaches $50:
● You buy for $20,000 and sell for $50,000—a $30,000 gain.
● The $30,000 “spread” is taxed as ordinary income when you exercise and is reported on your W-2.
● Any additional gains after selling are taxed as capital gains if held over a year.
● NSOs are available to employees, contractors, and advisors.
Restricted Stock Units (RSUs)
You’re granted 1,000 RSUs. After three years (vesting period), if the stock is worth $50:
● You receive $50,000 worth of shares.
● That amount is taxed as ordinary income when vested and reported on your W-2.
● The company may sell some shares to cover taxes.
● If you sell later at $60, the $10,000 gain is taxed as capital gains.
RSUs are simpler—no cost to acquire shares—but you can’t control when they’re taxed.
Key Considerations Before You Act
1. Taxes Can Be Tricky
● ISOs can trigger AMT at exercise, particularly if your income is high or the stock has appreciated significantly.
● NSOs and RSUs are taxed as income when exercised or vested.
○ Example: If 500 RSUs vest at $100, you’ll owe taxes on $50,000 of income, potentially up to 37%.
● A tax advisor or financial planner can help you prepare.
2. Timing Matters
● With ISOs and NSOs, you choose when to exercise, potentially managing taxes by acting in lower-income years.
● RSUs are taxed when they vest—you can’t control timing.
● Be thoughtful about your income level and stock price when taking action.
3. Risk of Value Changes
● Equity is only valuable if the stock has value.
● With private companies, determining value can be difficult.
● If the stock drops below your strike price, your options may be worthless.
● RSUs retain value as long as the stock is above $0, but may decline if the stock falls.
4. Vesting & Job Changes
● If you leave before equity vests, you lose the unvested portion.
● With ISOs, you typically have 90 days post-departure to exercise vested options—otherwise, they may convert to
NSOs.
● Review your company’s equity plan rules carefully.
5. Long-Term Goals
● Equity can help fund major life goals, such as retirement and home purchase.
● Selling RSUs right after vesting offers immediate liquidity.
● Holding shares for a longer period may result in lower taxes and greater gains.
● Planning helps align equity decisions with your risk tolerance and goals.
How to Handle Taxes
● Use your savings to pay taxes, allowing you to keep more shares in the long term.
● Alternatively, sell shares to cover taxes—this can be helpful in preserving cash flow.
● With ISOs, plan ahead for potential AMT, especially if your income exceeds thresholds (e.g., $220,700 in 2025).
● Some employers may automatically sell shares to cover tax obligations.
● A tax advisor or financial planner can help tailor the best strategy for you.
You Don’t Have to Decide All at Once
● Spread out exercising or selling shares to manage taxes and risk.
○ Example: Exercise 25% of your ISOs each year for four years.
● For RSUs, decide whether to hold or sell each batch as they vest.
Think About Your Dreams
Equity compensation is most valuable when it aligns with your life goals:
● If you’re focused on long-term growth, holding equity (like ISOs or RSUs) may make sense.
● If you need cash now, consider selling your shares after vesting or exercising them.
● Consult with an advisor to ensure your equity strategy aligns with your goals and level of risk comfort.
How Parallel Advisors Can Help
Equity compensation can be complex. Our team will help you:
● Develop an exercise strategy
● Optimize your tax plan
● Build a comprehensive financial plan that fits your life
Final Thought
Equity compensation is a powerful tool that allows you to share in your company’s success. ISOs, NSOs, and RSUs each
offer different benefits and challenges. With thoughtful planning, you can maximize your opportunity while managing taxes
and risk. We're here to guide you every step of the way.
This material is provided for informational purposes only and should not be construed as investment advice. Different types of investments involve varying degrees of risk. Discussion or information contained in this presentation does not substitute personalized investment advice from Parallel or another professional advisor of your choosing. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of Parallel Advisors, LLC (“Parallel”). Parallel cannot and does not provide warranties nor representations as to the reliability or accuracy of the content it shares.
