Forbes Councils Member
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Rory O’Hara, CFP®, CRPC®, is the founder and senior managing partner at Ausperity Private Wealth.
Equity compensation has long been a core part of how companies reward employees. For many young professionals in fast-growing tech firms, it now sits at the center of their financial lives and guides many of their decisions about wealth building and risk management.
Most of them understand the basics of equity, but the tax mechanics, liquidity rules and timing decisions are where things tend to get complicated. That’s because companies issue equity but rarely provide personalized guidance, leaving employees to navigate high-stakes choices entirely on their own.
This explains why so many people leave value on the table. When in-the-money options expire, and according to Carta that happens a lot, it’s not because the market crashes. Rather, it’s because employees had no structured plan or guidance for exercising (or buying company shares at the option holder’s predetermined option price).
How Different Types Of Equity Work
Each form of equity has its own rules and tax consequences:
- Restricted Stock Units: RSUs vest on a schedule, and the fair market value at vesting is treated as ordinary income. Companies usually withhold payroll and income taxes at a flat rate, but if the share price has risen, the final liability often exceeds the amount withheld, meaning you’ll need to write a check in order to make the purchase.
- Incentive Stock Options: ISOs can provide favorable tax treatment when employees meet holding requirements and manage the alternative minimum tax (AMT). Selling too soon turns potential long-term gains into ordinary income. Holding too long can push someone into the AMT, making them likely to owe much more than what was withheld for taxes.
- Nonqualified Stock Options: NSOs function like ISOs but without the same tax advantages. The spread between the strike price and market price counts as ordinary income at exercise, and any additional gains after that are taxed separately.
The Hidden Decisions Behind A Big Gain
Picture an employee who can buy 10,000 shares at a $10 strike while the stock trades at $30. On paper, they hold a $200,000 gain, the kind of outcome every equity holder hopes for. But that headline number hides a series of hard decisions. The value only becomes real if they navigate the rules that govern their award, and those rules can swing the outcome more than the stock price itself.
If the grant is an ISO, exercising at a large spread—where there’s a large difference between the option price and the value of the stock—can push them into the AMT, creating a tax bill that arrives before any sale. If the grant is an NSO, the spread becomes ordinary income at exercise, which can move them into a higher bracket and require substantial cash for withholding. If they receive RSUs, taxes come due at vesting even if they hold the shares, which can create liquidity pressure when appreciation outpaces the withholding.
These issues come with other immediate questions. Can the employee afford the exercise cost? How much concentrated exposure to their employer can they take on? What happens if the stock drops before they can sell? Together, these factors determine how much of the gain they keep and show why real-world outcomes often diverge from simple examples.
When Equity Is Private Instead Of Public
Private stock adds another layer. Even when employees understand the tax rules and exercise costs, liquidity can dictate what they can actually do. The first thing to realize is that the value of a private company is largely theoretical and may not become real for years, if ever. Another issue is that many startup employees hold equity that looks valuable on paper but cannot be sold for years due to firm restrictions or lockup periods.
These limits can increase concentration risk and leave employees exposed to swings they cannot control. Some firms now run controlled secondary sales for approved investors, but these windows remain limited and the company often sets the price.
For employees with private stock, these constraints become central to their planning. They must consider whether they can afford to exercise without near-term liquidity and whether it makes sense to hold a large stake in a company with an uncertain exit path.
Why Understanding The Rules Matters
Equity compensation can create long-term value, but results depend on how well employees understand the rules that shape their decisions. Award type, tax treatment, exercise timing and liquidity all influence what someone ultimately keeps, yet most people receive little guidance and must navigate complex choices on their own.
A clear understanding of how equity works allows employees to make decisions that align with their goals rather than reacting to deadlines or assumptions. That difference often determines whether equity becomes a meaningful asset or a missed opportunity.
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