Takeaways
- Equity compensation is a non-cash avenue for companies to reward employees.
- Equity compensation includes RSUs, options, milestone awards, and more.
- Equity compensation aligns long-term company performance with comp.
- Equity compensation can buoy a below-market cash compensation package.
- Equity compensation is issued by publicly traded companies and private businesses nearing a liquidity event, like an initial public offering (IPO).
Not all employee compensation comes in the form of salaries or cash bonuses. Equity compensation plans reward employees for company growth and can be a large part of your compensation package. Here’s what you need to know to maximize your stock-based compensation.
What Is Equity Compensation?
Equity compensation, often called stock-based compensation, is non-cash compensation. Publicly traded companies issue stock-based compensation to employees in addition to their cash compensation. The main goal of providing equity compensation to employees is to retain and attract top talent.[1]
Startups or private companies that are strapped for cash will issue stock-based compensation to employees to preserve cash and compete for talented employees, even with below-market cash compensation.
Your total compensation package includes cash compensation, like your salary, annual and spot bonuses, other employee benefits, and equity awards. Stock prices can swing wildly, and your equity compensation can be “out of the money” or have a near-zero value, which is why cash compensation is also a critical part of your overall compensation package. Here’s how your equity compensation works.
Read More: 7 Non-Cash Ways to Get Compensated
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How Equity Compensation Works?
Employers want to incentivize employees to meet long-term company goals. Equity compensation is an effective way to align employee and company performance. Additionally, it allows companies to reward high-performing employees while preserving their cash.
When you start a new job, you often are rewarded with a stock-based compensation award. Publicly traded companies can also issue stock as part of their year-end compensation package and give different types of equity awards depending on the company's size. For example, more established technology companies or unicorn startups issue RSUs, while smaller, growing companies may issue employee options or performance-based equity awards instead.
Smart Tip:
In a recent survey, over 43% of public companies issued stock-based equity awards to all employees and executives.[2]
When you receive your stock-based equity award, you will receive a specific number of shares of options on your grant date. Your awards will accrue to you based on a vesting schedule, which predetermines the dates you are eligible to receive your stock awards or exercise your options. Once you exercise your options, your stock awards are deposited into your stock brokerage account.
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5 Types of Equity Compensation
- Restricted Stock Units are stock-based compensation plans that issue employees a predetermined number of shares based on a vesting schedule (annually, quarterly, or monthly). You receive stock at the market price on your vesting date. (Your RSU compensation may be reported on your Form W-2).
- Stock Options are granted to new or current employees. Stock options are the right, but not the obligation, to purchase a company’s stock price at a set exercise price. There are two types of stock options: incentive stock options (ISOs) and non-qualified stock options (NSOs):
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- Incentive Stock Options give employees options that have favorable tax treatment. With ISOs, you can have Qualifying Dispositions or Non-Qualifying Dispositions, which affect how your gains are taxed. No tax is due when you exercise ISOs, only up the sale of your options. You might qualify for lower long-term capital gains if you hold your ISOs for at least 2 years past your grant date and one year past your exercise date.
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- Non-Qualified Stock Options are usually issued to startups and small public companies to motivate employees. These option awards are taxed differently than ISOs. You must pay ordinary income on the difference between the exercise and stock prices when you exercise NSOs.[3]
- Employee Stock Purchase Plans (ESSP) give employees the right to buy stock at a discount to the current market price. These plans are usually only available to employees who have been with the company for a year or more (check your company's policy). ESPPs allow you to defer part of your paycheck to buy shares of your company's stock at a discount, usually 15%, to the market trading price.
- Stock Appreciation Rights (SARs) are a contractual right to receive compensation for a set period. Instead of having to purchase shares, like with options, you can receive cash or shares in your company if your stock increases over a set period.
- Performance or Milestone Shares are usually reserved for higher-level employees like vice presidents or executives. They are issued to meet specific performance goals, such as hitting a top-line revenue number, selling a certain number of product units, raising capital, or surpassing a set market capitalization.
What to Consider with Equity Plans
Equity compensation plans can get complicated quickly. Depending on your level within a company and as you advance your career, your equity compensation package may make up a considerable part of your overall compensation package and benefits.
If you are new to receiving equity compensation, it’s a smart money move to talk with a tax professional and financial advisor to review the fine details of your equity compensation. Depending on whether you are granted RSUs, ISOs, NSOs, or other equity-based compensation, there may be tax consequences you need to be aware of.
Equity compensation heightens the complexity of your annual taxes. When you file your taxes, it can significantly shift whether you have a tax liability or are going to get a tax refund. If you have exercised stock awards, you may need to pay estimated taxes to the IRS before you file your annual tax return.
Read Also: What Is Tax-Loss Harvesting?
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Smart Summary
Equity compensation is a non-cash form of compensation that companies issue to employees. New employees typically receive new employee grants, while existing employees receive annual grants. Publicly traded companies grant stock awards, RSU, options, and other equity-linked rewards. You might need to open an online brokerage account to receive your rewards.
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(1) Morgan Stanley. State of the Workplace 2024 Financial Benefits Study. Last Accessed March 4, 2025.
(2) Morgan Stanley. The State of Equity Plan Management at Public and Private Companies. Last Accessed March 4, 2025.
(3) Internal Revenue Service. Taxable and Nontaxable Income 2024. Last Accessed March 4, 2025.
