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What You'll Learn In Today's Episode
  • There are 2 kinds of stock options: incentive stock options (ISOs) and non-qualified stock options (NQSOs). Both are usually non-taxable when granted. However, once exercised, their taxations differ significantly.
  • If your client gets any stock-based compensation, you need a copy of the grant document. It details important specifics of their individual situation. These include the vesting and expiration dates.
  • Record your clients’ vesting schedules in your CRM. Next, reach out as their options vest. Relay what choices they have. Notify them of approaching expiration dates, too. That’s lost potential value, if you don’t.
  • If you’re new to taxes involving stock compensation, reach out to another professional who’s well versed. It’s better to provide value by partnering with them than to gamble against the IRS. Pay attention, learn, and improve your skillset along the way, too.

Welcome back to the Retirement Tax Services Podcast! Steven’s guest Monday was financial advisor Ethan Pepper. Ethan’s Silicon Valley clients sometimes have multiple forms of equity compensation. Additionally, alternative minimum taxes (AMTs) often figure in. These make tax planning complicated.

As a result, Steven has devoted this episode to stock-based compensation. Where Monday’s show mostly focused on Ethan’s client, this one surveys the under-the-hood details.

Stock Options 101

Stock options grant the holder the right to buy a stock at a specified price.

The current market value doesn’t matter: The holder can buy it at the specified amount (sometimes called a “strike” or “exercise” price). Don’t make assumptions based on what normally happens. Other aspects of tax planning can be predictable. However, stock options are significantly different.

In fact, if your client receives stock-based compensation, get a copy of the grant. This reveals the specifics of their individual situation. Never just take their word for it.

In all honesty, this is for accuracy. It’s not about questioning anyone’s memory, understanding, or integrity. You can’t provide value without access to the documentation.

There are generally 2 kinds of stock options: incentive stock options (ISOs) and nonqualified stock options (NQSOs). There are several criteria for each type of stock option. Each of them must be met.

Doing so is the only way to make sure that they receive the correct tax treatment. So, secure a copy of any grant documents.

Stock-based Compensation: Track The Time

Both ISOs and NQSOs are typically granted tax-free; most grants aren’t taxable. However, they both usually come with vesting requirements. Vesting requires meeting prespecified benchmarks. Common ones include the passage of time and job performance metrics.

When you onboard a client with stock options, enter their vesting schedule in your CRM. Even if you’re new to equity-compensation-related taxes, this is an instant value-add.

As a result, when a vesting date approaches, you can reach out to them. Remind them that it’s near. Next, help them understand what their choices may be.

Note the current price of their shares, as well. In fact, this can determine whether or not it’s best to exercise an option at the time.

At the same time, keep an eye on expiration dates, too. Similar to best-by dates on groceries, they specify when an option-offering contract expires. Record these in your CRM. Use them to prevent missed value.

The biggest difference between the 2 kinds of options appears when they’re exercised: The exercise of an ISO is a non-taxable event unless an employee is subject to the alternative minimum tax (AMT).

Meanwhile, when an NQSO is exercised, the IRS gets involved. The difference between the exercise price (at the granting document’s date) and the fair market value of the stock at the time of the exercise is taxed. Count it as ordinary income.

When a stock is sold, any difference between the fair market value and the sales price is treated as a capital gain for NQSOs. On the other hand, ISO capital gains are based on the original exercise price.

Your Action Items

  • Make sure you get the actual agreement for stock-based compensation from clients. Even if you’re teaming up with another professional, you’ll need it. There’s no substitute for that data.
  • Record key data like vesting dates in your CRM. This enables you to consider the timing of your client’s award with any other strategies you recommend. Proactively reach out to them when a decision point is approaching.
  • Get and review all clients’ and prospects’ tax returns annually. All taxable income is going to flow through them. Help reduce anxiety by making clients aware when taxable events are on the horizon.

Steven has tax-related stock specifics in this edition of the Retirement Tax Services Podcast. Send feedback, ideas for future episodes, et cetera to

Thank you for listening.


Steven Jarvis:

And welcome to the next episode of the Retirement Tax Services Podcast: Financial Professionals Edition. I’m your host, Steven Jarvis, CPA. And in this show, I teach financial advisors how to deliver massive value to their clients through retirement tax planning. This week on Monday’s episode, my guest was Ethan Pepper, a CFP and enrolled agent and founder of Orchard City Wealth Management. Ethan specializes in clients with all kinds of stock based compensation. In our conversation, we focused really on one specific client situation that he has been handling recently. It was a great conversation and Ethan provided some really valuable insight from his experience, but we intentionally skipped over some of the details on the various kinds of stock compensation so that we could really just focus on Ethan’s client. So, on today’s episode, I’m going to go through a stock comp in tax one-on-one. Depending on your niche, you may not see stock comp frequently, but this discussion will help with the times you do come across these types of situations or potentially it’ll help you evaluate if a prospect situation really should be referred to someone who spends a large portion of their time in this area. Anytime you have a niche, as excited as we are about prospects, really learning how to disqualify potential candidates can be just as important as identifying the right ones to make sure that you stay really focused in that niche.

Two Kinds of Stock Options [02:00]


So, like I said, this is going to be a one-on-one level, so it’ll hardly be exhaustive, but a lot of great information. So, on the list of stock-based compensation, let’s start with stock options. Stock options, give the holder the right to purchase stock at a specified price, known as the strike price or exercise price, regardless of the current market price for that stock. The first thing we need to talk about with our options and really stock-based compensation in general is that you can’t make assumptions based on what normally happens. There really isn’t a ‘normally’ each grant is unique. Similar to my constant refrain of ‘make sure you get tax returns every single year’. If you have a client or prospect with stock-based compensation, make sure you get the grant document so you can review the details specific to their situation. This is definitely an area where you don’t want to just take the client’s word for what the details are. CPAs typically use the phrase ‘trust, but verify’. This isn’t a matter of not trusting your client’s memory or their understanding; these are complex areas and to really provide them value, you need to see the actual documents. Okay. Stock options really come in two flavors, incentive stock options known as ISOs and non-qualified stock options or NQSOs. As a side note, it’s always fascinated me which acronyms people decide to pronounce as words like ISO versus just saying all the letters like NQSL. My favorite in the accounting world, of course, being the PCAOB, which one of my professors constantly referred to as peekaboo, always with a completely straight face.

Okay. There are several criteria for each type of stock option that have to be met to ensure that the options receive the correct tax treatment. So again, you want to make sure you are getting the actual granting documents, if you have clients who have been granted options. Since this is the one-on-one level, I’m going to focus on decision points and taxable events as it relates to the options, as opposed to diving into all of those criteria. But you’re going to want to make sure that this gets evaluated either by yourself, if this is something you’re more comfortable with, or that you partner with another professional to look through and make sure that the way the options were granted, you’re correctly understanding which type of option it is. Typically for both NQSOs and ISOs. The granting of the options is not a taxable event. Both types of options commonly come with vesting requirements. That can be one or some combination of different benchmarks, including the passage of time and potentially performance metrics. One way you can add value to your clients, even if you are not an expert in this area yet, is to record their vesting schedule in your CRM and reach out to them as their options best to remind them that it is happening and help them understand what their options at that point might be. In addition to needing the options to vest, the current share price is also going to be important in deciding whether to exercise the options. The other date that you really want to take out of that grant document is the expiration date. Most options come with some kind of expiration timeframe. And so, recording that in your CRM and letting your clients know well in advance, when that expiration date might be approaching is a great way to make sure that they don’t miss out on the potential value.

The Difference Between ISOs and NQSOs [05:12]


Once an employee starts exercising options, we start to see the differences between ISOs and NQSOs for tax purposes. For ISOs the exercise of the options is still not a taxable, unless the employee is subject to the alternative minimum tax or AMT. In contrast when NQSOs are exercised, the difference between the exercise price – which was set in the original granting document – and the fair market value of the stock at the time of exercise is taxed as ordinary income. When the stock is ultimately sold, which at times can be simultaneous with the exercise of the option, any difference between the fair market value at the time of exercise and the sales price is treated as a capital gain for NQSOs. But for ISOs, the capital gain is calculated on the original exercise price. There’s a little bit of a difference there where ISOs are all under the capital gains rates. And for NQSOs, there’s a portion that’s going to be ordinary income and a portion that’s going to be capital gains.

So, there can be huge tax savings from ISOs because of that capital gains treatment. But there are also pitfalls to watch out for, to make sure that they maintain that status and that an employee doesn’t unknowingly get pushed into the alternative minimum tax. You can also provide value to your clients who have options by making sure you are planning ahead for any cashflow needs. While some options have the option to net settle, which does not require a cash outlay from the employee. If they wish to exercise and hold the stock, they will need to have cash to exercise the options. And for NQSOs to pay any tax due as a result of the exercise.

Two Varieties of Stock Awards [06:45]

Okay. So, switching to stock awards, again, we have two basic varieties, restricted stock awards and restricted stock units also known as RSUs. In contrast to options, which do not result in any stock ownership until the options have been exercised. Stock awards are dealing with direct stock. Although for RSUs, the vesting is still critical to ownership occurring. For restricted stock awards, the recipient typically has to pay for the stock, usually at some kind of discount or preferential rate. And as a result owns the stock at the grant date, commonly there are vesting conditions for restricted stock awards, which is what makes them restricted. But at the grant date, those shares are issued and owned by the recipient. Which is different than RSUs, which until they vest the stock really isn’t owned by anyone it’s just held as an option for that employee at a future date, or when those best team requirements are met. Similar to options, it is still going to be important to get the granting documents so you have clarity on the type of stock award and the vesting conditions. For restricted stock awards the taxable events by default are when the stock vests and when the stock is eventually sold, if no other elections are made when the stock vests, any change in fair market value from the original purchase as is taxes, ordinary income, and at the time of sale, any additional change in the value of the stock is taxed at capital gains rates.


Now, one of the reasons I phrase it that way is that one potential benefit of restricted stock awards is that you can make what is known as an 83B election to pay the ordinary tax upfront, and have any remaining appreciation of value taxed at capital gains rates. There’s a short time period for being able to make that election. So, it’s really important to make sure that you’re asking good questions of your clients and knowing when these types of things go on so that you can help them understand what those decision points are. The potential risk of making this election is that if a stock is forfeited later, you don’t get a refund of the tax you already paid at those ordinary income tax rates. But the election is available and can be advantageous in certain situations. So it is certainly worth knowing about and considering.


So that takes us to RSUs when RSUs are taxable, it can be a bit more complicated depending on the vesting conditions associated with the units. If the units only have a time restriction on vesting, when the units vest the full value of the stock at the time that they vest is taxable as ordinary income, and then any additional appreciation between the vesting date and the sale of the stock is taxed at capital gains rates. However, RSUs at times will have liquidation conditions on the units in addition to time-based conditions, which essentially says that the units don’t vest and can’t be sold until the company is liquidated. And this case, when the time requirement is met, there is no taxable event. Cause only a portion of the vesting has been met, and at the time of the company’s liquidation, the units would vest and be sold at the same time. Meaning the full value of the stock on that date will be taxed at ordinary income rates. Like I said, at the beginning of the episode, this really is meant as a one-on-one overview of key points to be aware of when these types of compensation come up. If you are new to these areas, I definitely recommend you work with your client and a tax professional who specializes in this area to make sure everything is addressed correctly. The goal of this is so that you feel prepared to at least ask some initial questions and get the process started because with the vesting schedules that typically come with stock-based compensation, there could be multiple years of impact on the planning recommendations you are making. And similar to other topics we’ve discussed just the model of what you are doing versus their tax professional. It’s possible that you can identify these things are going on much earlier than the tax professional might even be aware of it. And so you can help start it with the understanding of making sure that decisions are being made at the right times.

Hey podcast listeners, are you interested in content that provides you with action steps that you can take to deliver massive tax value to your clients? Then you are going to love our powerful training sessions online. At Retirement Tax Services, we meet with the top producing, highly innovative financial advisors from across the country. We discuss their most pressing tax concerns and strategies on how they can take tax theory and transform it into tax planning for their clients. Register today at, or click the link in the show notes. Aren’t you ready to start being a part of the conversation? Yeah, I thought so. We’ll see you online.

Action Items [11:14]


For action items for today’s episode – first and foremost, make sure you are getting the actual agreements for any stock-based compensation your clients are the recipients of. That’s going to be your best starting point. Even if you were ultimately going to team up with another professional to make sure everything is handled correctly, get the actual granting document. The next action item is to make sure you record key data in your CRM so that you are considering the timing of your client’s awards with other strategies you are recommending and proactively reaching out to them when they have decision points or there are tax implications for a given year. Whether that’s due to vesting or the potential expiration of options. Finally, of course, make sure you are getting and reviewing tax returns for all of your clients. All taxable income is ultimately going to flow through their returns, and you can help relieve some of your client’s anxiety by showing them ahead of time where these taxable events will show up on their 1040. And then making sure that they get reported correctly after the taxable event has occurred. All right. That’s all for today. Good luck out there everyone! And remember to tip your server, not the IRS!


The information on this site is for education only and should not be considered tax advice. Retirement Tax Services is not affiliated with Shilanski & Associates, Jarvis Financial Services or any other financial services firms.

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