Equity compensation
Equity compensation pays employees in company stock or rights to it: stock options, restricted stock, restricted stock units, and employee stock purchase plan options.
Equity compensation usually reaches payroll at set events: an option exercise, the lapse of a restriction on shares, or a later sale of the shares. The IRS recognizes three kinds of employee stock options: incentive stock options (ISOs), employee stock purchase plan (ESPP) options, and nonstatutory (also called nonqualified) options. ISOs and ESPP options are the statutory options. Restricted stock units (RSUs) generally pay out in shares at settlement; confirm their income tax, Social Security, and Medicare treatment with a qualified professional before the units vest.
When does equity compensation become wages?
Generally, nonstatutory option income arises when the employee exercises the option, and restricted stock income when the restriction lapses. Both are supplemental wagesSupplemental wages. Supplemental wages are wage payments to an employee that are not regular wages, such as bonuses, commissions, severance pay, and back pay.Click to open the term for federal income tax withholding. Statutory options create no Social Security, Medicare, or federal unemployment (FUTAFUTA. FUTA is the federal unemployment tax you pay on the first $7,000 of each employee’s wages a year, with nothing withheld from pay.Click to open the term) wages, at exercise or on any later disposition of the shares. On a disqualifying disposition of statutory option shares, or a qualifying disposition of discounted ESPP shares, you still report income in box 1 of Form W-2Form W-2. Form W-2 is the annual wage and tax statement you give employees and file with the Social Security Administration, reporting wages paid and taxes withheld.Click to open the term. Federal income tax withholding on that income isn’t required.
| AWARD AND EVENT | AMOUNT THAT COUNTS | INCOME TAX WITHHOLDING | FORM W-2 |
|---|---|---|---|
| Nonstatutory option, exercise | Stock’s fair market value over the exercise price | Required, as supplemental wages | Boxes 1, 3 (up to the wage base limit) and 5; code V in box 12 |
| ISO, disqualifying disposition | Generally, the spread between exercise price and value at exercise | Not required | Box 1 |
| ESPP option, disqualifying disposition | Spread between exercise price and value at exercise | Not required | Box 1 |
| ESPP option, qualifying disposition | The discount portion | Not required | Box 1 |
- Publication 15-B (2026), Employer’s Tax Guide to Fringe Benefits
- 26 CFR § 31.3402(g)-1 - Supplemental wage payments.
General information, not legal or tax advice. Apply current federal and state rules with qualified guidance.