‍RSA vs RSU vs Stock Options

When offering equity compensation, companies have several options to choose from, with Restricted Stock Awards (RSAs), Restricted Stock Units (RSUs), and stock options being the most common.

Each option provides unique benefits and challenges for both employers and employees.

What are RSAs?

Restricted Stock Awards (RSAs) are a type of equity compensation in which a company grants its employees actual shares of its stock at the time the grant is issued.

Employees own the shares immediately upon issuance, though there may be a purchase price requirement, such as paying a nominal amount for the shares.

Despite outright ownership of shares, RSAs are considered “restricted” because they are subject to a vesting schedule. These vesting conditions, often tied to time or performance milestones, prevent employees from selling or transferring the shares until they vest. 

Why do companies grant RSAs?

RSAs are usually granted when the company’s fair market value (FMV) is low.

By receiving shares as compensation and making a Section 83(b) election, employees can minimize their tax burden. 

The 83(b) election allows employees to pay taxes on the shares' FMV at the time of the grant rather than at the time of vesting. So the taxable income is significantly reduced.

Moreover, any future appreciation in the stock's value is taxed at the long-term capital gains rate, provided the shares are held for more than one year from the grant date.

This favorable tax treatment for employees makes RSAs an attractive option for employers.

Additionally, RSAs have a simpler structure. Unlike stock options, they don’t require employees to "exercise" them.

What happens to RSAs after termination?

Upon termination:

Unvested shares: Any unvested shares are typically repurchased by the company and forfeited.

Vested shares: Vested shares are owned by the employee and remain with them even after termination.

Tax implications: If an employee makes a Section 83(b) election, they pay taxes on the full grant upfront, even for shares that are later forfeited, which can result in a financial loss. 

Without an 83(b) election, the employee only owes taxes on the vested shares, but the taxes may be higher since they are based on the fair market value (FMV) at the time of vesting.

Taxes on RSAs

Restricted Stock Awards (RSAs) are taxed based on the fair market value (FMV) of the shares when they vest. However, employees can make a Section 83(b) election at the time of the grant to potentially reduce their tax burden:

Section 83(b) election

A Section 83(b) election is a provision of the U.S. Internal Revenue Code that allows employees to choose to be taxed on the fair market value (FMV) of restricted stock awards at the time of the grant, instead of when the shares vest.

RSA with no 83(b) election: Employees are taxed at the time of vesting. The FMV of the shares at each vesting milestone is treated as ordinary income and taxed accordingly. If the stock value increases over time, employees face higher taxes as the shares vest.

‍RSA with 83(b) election: If the employee receives the shares as compensation for their work (instead of paying cash), the fair market value (FMV) of the shares at the time of the grant would be considered ordinary income and subject to income tax.

The 83(b) election allows the employee to lock in the tax obligation early, which can be beneficial if the FMV is low at the time of the grant. Any future appreciation in value would then be taxed at the capital gains tax rate.

In contrast, if the employee purchases the shares for cash (e.g., $1), and the FMV at grant is the same as what they paid, the taxable income is $0 because there’s no immediate gain.

They would only be liable for capital gains tax if the shares appreciate in value later.

What are RSUs?

Restricted Stock Units (RSUs) are issued when a company promises to grant shares of its stock to an employee at a future date, subject to certain conditions. 

Unlike RSAs, RSUs do not involve actual stock ownership until the units vest. 

Once vested, the RSUs convert into shares or, in some cases, cash equivalent to the stock's value.

Why do companies grant RSUs?

Restricted Stock Units (RSUs) are simpler to manage and provide more certainty for both employees and employers:

- Unlike RSAs, RSUs don’t require employees to pay a purchase price or make a Section 83(b) election, but they also lack associated tax advantages as a result.

- RSUs are also administratively easier to manage, as shares are only issued at vesting. This means that the applicable legal and regulatory obligations are triggered at vesting, rather than at grant like with RSAs.

- RSUs are not dependent on the company's stock price exceeding a strike price. Employees automatically receive the value of the shares upon vesting, offering a more predictable incentive.

What happens to RSUs after termination?

Restricted Stock Units (RSUs) do not represent actual shares until they vest, and the impact of termination is generally simpler:

Unvested RSUs: Unvested RSUs are forfeited upon termination.

Vested RSUs: Vested RSUs are converted to shares and usually remain the employee’s property after termination. 

However, private company RSUs may have additional conditions, like requiring a liquidity event (e.g., an acquisition or IPO) to deliver the shares. 

If these conditions aren’t met before the shares expire, the employee will lose them. 

Tax implications: Taxes on RSUs are paid upon vesting, so there are no tax consequences for forfeited units. Employees only owe taxes on RSUs that vested before termination.

Taxes on RSUs

Restricted Stock Units (RSUs) are taxed when they vest and again at sale: 

At vesting: The FMV of the shares at the time of vesting is treated as ordinary income and is subject to income tax.

At sale: Once the shares vest, if the employee holds them for more than one year before selling, any increase in value will be taxed at the long-term capital gains tax rate. If the shares are sold within a year, the gains will be taxed at the short-term capital gains tax rate.

What is a stock option?

A stock option is a type of equity compensation that gives an employee the right, but not the obligation, to purchase a company’s shares at a predetermined price, known as the strike price/exercise price, within a specified time frame.

The value of the stock option lies in the potential increase in the company’s stock price. It enables employees to buy shares at a lower strike price and sell them at a higher market price.

Stock options are often tied to a vesting schedule, requiring employees to stay with the company or meet performance milestones before they can exercise their options. 

What happens to stock options after termination?

Unvested stock options: Unvested stock options are typically forfeited immediately upon termination.

Vested stock options: Vested options remain exercisable, but only for a limited period after termination. This post-termination exercise period is defined in the grant agreement or the company’s equity plan. If the employee fails to exercise their vested options within this window, the options expire and are forfeited.

Tax implications: For Incentive Stock Options (ISOs), exercising them beyond the standard post-termination window often converts them into Non-Qualified Stock Options (NSOs), which are taxed at higher rates.

Taxes on stock options

The tax treatment of stock options depends on whether they are Incentive Stock Options (ISOs) or Non-Qualified Stock Options (NSOs):

NSOs

At exercise: The difference between the exercise price and the FMV of the shares is treated as ordinary income and taxed immediately.

At sale: Any gain or loss from selling the shares is taxed as capital gains, depending on the holding period (short-term or long-term).

ISOs

At exercise: No immediate tax liability unless the employee triggers the Alternative Minimum Tax (AMT), which considers the spread between the exercise price and FMV as income.

At sale: If the shares are held for at least one year after exercise and two years from the grant date, the entire gain is taxed at the long-term capital gains rate. If the holding period requirements are not met, ISOs are also taxed as NSOs.

Note: Stock options offer a level of flexibility that RSUs and RSAs do not. For example, employees can choose when to exercise their options, providing them with control over the timing of their tax liabilities.

RSA vs RSU vs stock options: Which is better for your company?

RSUs are commonly used by companies in the U.S., especially by late-stage or public companies. Their popularity stems from their predictable value, making them appealing in established markets where employees expect immediate and tangible rewards.

In contrast, startups in regions such as Europe, India, and other markets often prefer to grant stock options, which align well with the growth-focused nature of early-stage companies.

RSAs may also be used by some startups, particularly when the fair market value (FMV) of shares is still very low, minimizing the tax and financial burden on employees.

From an administrative standpoint, RSUs are generally easier to manage compared to RSAs or stock options.