Stock Options vs. Restricted Stock Units (RSUs): How Do They Differ?

Stock options and restricted stock units (RSUs) are both forms of equity compensation offered in some companies. 

Depending on the company, they may only be offered to executives at the top of the company or they may be offered to most employees.

Generally, you’ll find out about stock options or RSUs when you’re negotiating your compensation package before you get hired. Companies tend to offer one or the other, not both. 

That said, it is possible you could be given the choice of choosing between the two. Alternatively, you may have a job offer from one company that offers stock options and another company that offers RSUs.

Here’s what you need to know about stock options vs. RSUs.

Stock Options

There are technically many types of stock options that work in slightly different ways. That said, understanding the basics of stock options isn’t too difficult.

How stock options work

In general, you’re given stock options as part of your compensation package. 

The details of your stock options will be given to you in a document outlining exactly how they work for your situation. Each person’s stock options can work in different ways.

When looking over the document describing your stock options, here’s what you need to look for.

First, you’ll be granted a certain number of stock options. This is the number of shares of common stock your stock options enable you to buy.

Next, a strike price is listed. The strike price is the price you have to pay to buy each share of stock.

There may also be a vesting schedule that details how you’ll earn your options over your vesting period. You usually don’t get your options up front. 

Instead, you may earn a portion of your options after each year of service. For instance, you may vest in 20% of your options each anniversary for the first five years. 

When you become vested in your options, you have the ability to exercise your vested options. You do this by paying the strike price. This allows you to exchange one stock option for one share of stock.

You should also read your document to see how long your stock options last and what happens to them should you decide to leave or you get fired from the company. 

Some options are available for a set amount of time. Others expire when you no longer work for the company or a certain number of days after you leave.

How Stock Options Can Be Financially Beneficial

Stock options can be very lucrative for employees. Unfortunately, they can also be worthless. It all depends on you and your company.

Stock options are usually great because they normally give you the ability to buy stock at below the market rate. 

The strike price is usually set when your stock options are granted to you. The strike price may be below the market value of the shares when the contract is issued. 

The stock price can also rise over time, making the option strike price seem like a bargain when you vest in your options in your future.

Stock options are financially beneficial as long as the market value of the stock is above the strike price, you can exercise the options and you can sell the shares. 

If you never set aside money to exercise your stock options, they’re essentially worthless. If you can’t pay for the options, you have nothing to gain.

Unfortunately, stock options aren’t always beneficial. 

Finances can be tight in start up companies. Companies use stock options as part of compensation packages because they don’t require the company to pay you cash. 

Stock options allow the company to hire talented individuals without having to pay them their true market value in cash.

In this sense, compensation in the form of stock options is a gamble. If the company does well and eventually goes public, you could become immensely wealthy. If the company fails, you get nothing.

Things get trickier if you work in a company that isn’t public yet, more on that later.

How Stock Options Are Taxed

How your stock options are taxed depends on the type of stock options you have and your specific situation. 

No matter what type of stock options you have, it’s always best to consult a tax professional to see how your particular options will impact your tax situation now and in the future.

When you exercise incentive stock options (ISOs), you may end up being subject to the alternative minimum tax, but you don’t have to pay ordinary or capital gains taxes.

Instead, you’re taxed in the year you sell the stock. How you’re taxed depends on the information provided on Form 3922, Transfer of Stock Acquired Through an Employee Stock Purchase Plan.

Non-qualified stock options (NQSOs) are more complex. You may be taxed when you’re granted the options, when you exercise the options and when you sell the stock.

When you receive options, you may have to include the value of your options above fair market value in your income. However, if the stock price can’t be readily determined, you don’t have to do this.

When you exercise the stock options, you must include in your income the difference between the fair market value of the stock and your strike price. This is reported as part of your income on your W-2 from your employer.

When you sell the stock, capital gains tax will apply to the gain.

Restricted Stock Units

Restricted stock units work in a pretty straightforward way. Here’s what you need to know about RSUs.

How RSUs work

Restricted stock units are easier for most people to understand. When you’re granted RSUs, you’re normally told how many shares you will eventually receive and how they vest.

Vesting typically occurs over time or based on meeting certain goals. Check your RSUs to see how yours will vest.

When the RSUs vest, you automatically get shares of stock equal to the number of RSUs that vest. 

How RSUs Are Financially Beneficial

The financial benefits of RSUs are easy to understand. Once your RSUs vest, you get the shares. It’s that simple. 

At that time, you can choose to hold the stock or sell it to get the cash as long as the company is public. It’s up to you.

There are tax issues to consider, though.

How RSUs Are Taxed

Taxation of restricted stock units (RSUs) is much simpler, but you should still consult a tax professional. 

They can help you plan to see how it will impact your tax situation in any given year or over a period of time. They may be able to find ways to help you pay less tax, but they can generally only help before you get your RSUs, not after.

Most of the time, you pay ordinary income tax on the value of your RSUs when you receive the stock. 

If you get 10 shares of stock and the stock price is $100 per share at the time, you receive $1,000 of ordinary income subject to the usual withholding that takes place from your paycheck.

Your company will typically withhold the appropriate amount of money from your paycheck or will redeem an appropriate amount of stock to pay for the taxes. 

When you eventually sell the stock, you pay capital gains taxes on the sale like you would with any other stock you buy. 

Public vs Non-public Company Stock Options and RSUs

One big issue with both stock options and RSUs is what happens if your company isn’t publicly traded.

Essentially, this means you may be able to get stock through RSUs or stock options, but you may not be able to sell it.

Private companies normally keep tight control of their stock before they go public due to rules and regulations. 

You can only sell your stock in certain rare instances, such as if the company decides to repurchase stock from employees as a way to give them access to their stock compensation.

The other main way you can sell stock is once your company goes public. Public companies are traded on stock exchanges, so you can sell your stock to anyone. If your company never goes public, you may never be able to sell your stock shares.

This is an important consideration to think about before you accept stock options or RSUs as part of your compensation.

Choosing Between Stock Options vs. RSUs

In the rare instance when you get to choose between stock options or RSUs, it usually makes the most sense to consult a financial advisor and tax professional. These professionals can help you determine what is best for your specific situation and financial plan. 

This is extremely complex and choosing the wrong type of compensation can cost you quite a bit of money based on the tax treatment and potential gains.

That said, here are a few things you should consider in addition to the potential tax impacts.

Stock options are nice because you generally have a bit more control. While you may vest in your stock options, you usually don’t have to exercise them right away. This can help you with tax planning or allow you to wait to figure out if you really want to exercise them.

Unfortunately, stock options aren’t all good. If the market value falls below the strike price of your options, you’d essentially lose money by exercising your options. 

Restricted stock units have some benefits over stock options, too. The biggest benefit is you don’t have to spend money to exercise them. You automatically get the shares when they vest without putting out any money yourself no matter how much the stock is worth. 

The downside is you don’t get to control when they vest unless you negotiate this before your RSUs are granted to you.

Most people don’t get to decide if they want stock options or RSUs. 

If you’re in the lucky position of getting to decide between stock options and RSUs, you must choose what’s best for you. 

Financial advisors and tax professionals can help you explore the impacts of your decision, but you get the final say.

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