Stock Compensation: It's Complicated

If the compensation is in the form of a restricted stock grant, then taxes will be due upon the vesting of the grant. A professional advisor can counsel the executive on the most advantageous way to pay off the tax. It might make sense to sell enough of the stock to pay the tax on the rest, or if there's an expectation that the stock price will rise, the shareholder could retain the entire grant and pay the tax from some other source.

Performance units are awarded based on the overall success of the company per pre-prescribed metrics, not just stock price. They represent a commitment by the employer to award a target number of shares (or the cash equivalent) at a future date, once vested. The actual number of shares varies based on performance relative to defined goals. Performance unit vesting can accelerate when the performance targets for the entire company are met. These have become increasingly popular as an incentive because everyone has a stake in a positive outcome, and it forces all the employees to be rowing the same direction.

Incentive stock options are less common than they were in years past, but some companies still offer them. With this type of compensation, no tax is due at the vesting date, but the stock must be held for at least one year to transfer it from ordinary income to long-term capital gains. But even if the individual is able to avoid ordinary income taxes, the stock options may be subject to the Alternative Minimum Tax (AMT), so there may be the need for intricate planning around these kinds of options.

In conjunction, a potential tool to use with your equity compensation would be your company's deferred compensation plan. A deferred compensation plan is different from a 401(k), but the two should be working in tandem to help executives maximize the pretax value of whatever type of equity compensation they are granted.

What we've discussed here just touches the surface of what goes into planning for executives with equity compensation plans, but it does serve to illustrate how complicated the subject can be. For advisors working with clients in this situation I suggest that they draw up two plans — one with the equity compensation and one without — before deciding how and when to execute them. A client who has enough of a nest egg to be financially comfortable for the rest of their life (I suggest modeling out to age 100) can wait for the best moment to cash out, while someone who needs the money in order to retire or do whatever they want with their lives might need to pull the trigger sooner.

Ultimately, the goal of anyone fortunate enough to be granted equity compensation is to exercise their options in a way that maximizes the price, while also deferring and minimizing taxes to as great a degree as possible. That's one of the areas where advice from a knowledgeable financial planner can make a tremendous difference in the outcome.

Kenneth Van Leeuwen is managing director of Van Leeuwen & Co., a wealth management firm he founded in Princeton, New Jersey, in 1997.