We have just finished filing personal tax returns for 2019 and want to assist you in planning your income for the balance of 2020 and for 2021. 

October through December is the time when companies make decisions on the timing and structure of future income for senior level employees/management/executives.

Most employees will never have to make these decisions. Compensation is established and predictable. You will have a certain set of benefits and a predictable salary/wage.

Executive management in many companies has the option of receiving their income in a variety of methods – some immediately taxable, some partially taxable and most not taxable until a future event occurs.

This is where the employee can take advantage of the wealth building the employer’s compensation plan provides.

Over the next few days, we will periodically add explanations about your compensation, how it is taxed and how to use the various plans and opportunities to maximize your income and build your Workplace Wealth.

There are several categories of income and their taxation is treated differently.

  • Immediately taxable
    • Salary and wages
    • Incentive compensation such as bonuses
    • Unrestricted stock grants
  • Partially taxable
    • Non-qualified deferred compensation.
      • Applicable Social Security and Medicare taxes will be withheld but no income taxes.
  • Deferred for future taxation
    • Qualified Plans
      • Nondiscriminatory
      • 401(k), 403(b), 457 Plans
    • Non-Qualified Plans
      • Discriminatory
      • “Golden Handcuffs”
      • Options
      • Restricted stock and restricted stock units
      • SARs
      • 83(b) Elections





The vast bulk of the income paid to employees is immediately taxable.

We are all familiar with the basics of our income, whether it be hourly wages or an annual salary.

 We agree to the amounts, complete the W-4s for withholding, etc., and select our benefits and deferrals and off we go, never to consider the issues again.

This is the first mistake most employees make with their income. If you constantly owe the IRS or the state each year or have a big refund coming (“Disney Money”), revisit your withholding amounts and change them so that the amount owed by you or to you is a minimal amount. There is no need to scramble every year to make a payment or to have made an interest free loan to the IRS or your state.

Next, check the benefits you have selected. Life situations change so you should be sure your company benefits are in line with your current situation. Are you taking the maximum advantage of the benefits your employer is offering? Health insurance, Health Savings Account (HSA), dependent care benefits, Flexible Spending Accounts (FSAs), etc. Review these choices annually and be sure you understand each of these benefits. Most of these elections are made in the Fall for the next year. Be sure to know your company’s deadlines.

 For retirement plan contributions, most people set the allocations in their 401(K) type plans at hiring and never change the allocation during their work life. As you get older, your ability to absorb risk (losses) decreases. Review the allocations in your 401(k) type plans annually.

Life changes may necessitate changes to your beneficiaries for employer provided life insurance or 401(k) plans. Marriages, births, death or divorce may impact your beneficiaries. Review these at least annually.

All employees need to pay attention to their entire compensation plan. That is the beginning of using your employer to create your own Workplace Wealth. Pay attention. These little things can make a big difference!



A non-qualified deferred compensation plan allows an employee to earn wages, bonuses, or other compensation in one year but receive some or all of the earnings in a later year or years.

Doing this provides income in the future and may reduce the tax payable on the income if the person is in a lower tax bracket when the deferred compensation is received.

The company must have a plan that is in accordance with IRS requirements. The plan must be written and will specify at the time an amount is deferred, the amount to be paid, the payment schedule, and any event that will result in payment. There are six permissible events that will initiate payment of the deferrals:

      • a fixed date,
      • separation from service,
      • a change in ownership or control of the company,
      • disability,
      • death, or
      • an unforeseen emergency.

The employee will make an irrevocable election to defer compensation before the year in which the compensation is earned.

The amount deferred is still subject to FICA and Medicare taxes in the year it is earned, so these taxes are withheld.

Some employers will “finance” these plans with cash value life insurance to ensure the employee that the cash will be there in the future.

There are several negatives associated with these plans:

  • A strict distribution schedule.
    • you must choose a distribution date at some time in the future.
    • You must take distributions on the designated date, regardless of whether you need the funds or how the market is doing.
  • No Early Withdrawal Provision. You must withdraw funds according to the distributions schedule and no earlier.
  • The amount deferred is NOT guaranteed by ERISA. You get in line with other creditors if a problem arises.



Qualified Deferred Compensation plans are governed by ERISA – Employee Retirement Income Security Act passed in 1974. These plans include defined contribution plans such as 401(k), 402(b) and 457 plans and, if the company has a plan in place, it must be offered to all eligible employees. Deferrals by the employees are set apart for the sole benefit of the employee. Creditors cannot access these accounts if the company has financial problems.

The employee has a choice whether to participate or not. If the employee is eligible and chooses to participate, the following will usually occur:

  • Employee tells the employer how much of their income they wish to defer to the plan.
    • The maximum for 2020 is $19,500 with a catch-up provision of $6,500 for employees 50 and over.
    • The money is taken from the employee before federal income taxes are withheld.
      • The deferral is still subject to FICA and Medicare taxes.
      • The deferrals may also be subject to state income taxes in the year of deferral.
    • The employer may have a formula to match some or all your deferral.
    • The investments are given to a third-party plan administrator/custodian who is responsible for investing it based on your instructions.
      • You make the investing decisions.
      • You are generally allowed periodic changes during the year.
    • The investments are protected from the employer’s creditors in the case of bankruptcy.
    • If you leave the employer, you can make a tax-free roll over of your account into the account of your new employer (if their plan allows this) or into your own IRA.



There are two types of Employee Stock Options:

  • Non-qualified Stock Options (NQs) and
  • Incentive Stock Options (ISOs).

 Each is taxed quite differently.

Taxation of Non-qualified Stock Options - NQs

When you exercise Non-qualified Stock Options, the difference between the market price of the stock at the grant and the exercise price (called the spread) is considered as ordinary earned income, even if you exercise your options and continue to hold the stock.

  • Earned income is subject to payroll taxes (Social Security/FICA and Medicare), as well as regular income taxes at your applicable tax rate. 
  • All income from the spread is subject to ordinary income taxes.
  •  If you hold the stock after exercise, and additional gains beyond the spread are achieved, the additional gains are taxed as a capital gain (or as a capital loss if the stock value went down).

Taxation of Incentive Stock Options - ISOs

The built-in gain on grants of incentive stock options is not subject to payroll taxes. It is subject to tax, as a preference item for the AMT (Alternative Minimum Tax). 

When you exercise an incentive stock option there are a few different tax possibilities:

  • You exercise the incentive stock options and sell the stock within the same calendar year: In this case, you pay tax on the difference between the market price at sale and the grant price at your ordinary income tax rate. No AMT.
  • You exercise the incentive stock options but hold the stock: In this situation the difference between the grant price and the market price at exercise becomes an AMT preference item. Exercising these incentive stock options might mean you will pay AMT (Alternative Minimum Tax). You may get a credit for excess AMT tax paid in future years, but it may take many years to use up this credit. If you hold the shares for one year from your exercise date (two years from the grant date of the option), the difference between grant price and sale price when you sell the options is taxed as long-term gain rather than ordinary income. If your ordinary tax rate exceeds your AMT tax rate you may get to use some of the previously accumulated AMT credit. 



Once you reach the upper echelons of corporate employment, your compensation will begin to differ dramatically from hourly and other salaried employees.  A significant portion of that compensation will be based on performance - your performance as an executive and the overall performance of the company. A performance bonus is the beginning of the new forms of compensation you can expect. Depending on the company, additional forms of compensation will be:

  • Executive Incentive Compensation - annual cash incentive (bonus) paid, generally in the first quarter of the subsequent year, based on the prior year’s performance
  • Performance Share Units (PSUs) - granted annually to eligible executives
    • A “PSU” is equal in value to one share of common stock of the Corporation. PSUs are generally convertible into shares of Common Stock to the extent the associated pre-established performance targets are achieved.
    • These pre-established performance targets include:
      • diluted earnings per share;
      • total shareowner return;
      • working capital and gross inventory turnover;
      • revenue growth.

 A PSU grant may be subject to a single or multiple performance targets.

The grant will specify the applicable performance targets, the performance period and vesting date, the minimum performance required for vesting, the range of vesting relative to measured performance and, if multiple performance targets apply, the relative weighting of each.

  • Payment/Conversion of PSUs
    • PSUs will generally be converted into shares of Common Stock, effective as of the vesting date as a result of the achievement of performance targets.
    •  If performance targets are not met, the PSUs that do not vest will be cancelled without value.
  • If the recipient terminates employment prior to the end of the performance measurement period for any reason other than death, disability, or retirement, unvested PSUs will be cancelled as of the termination date.
  • Restricted Share Units (RSUs)
  • A restricted stock unit (RSU) is a form of stock-based compensation issued by an employer to an employee in the form of company shares.
  • Units are issued to an employee through a vesting plan and distribution schedule after achieving required performance milestones or upon remaining with their employer for a particular length of time.
  • RSUs give an employee interest in company stock but they have no tangible value until vesting is complete.
  • The restricted stock units are assigned a fair market value when they vest. Upon vesting, they are considered income, and a portion of the shares is often withheld to pay income taxes, usually referred as “cashless” transaction. The employee receives the remaining shares and can sell them at his or her discretion.
  • RSUs are restricted during a vesting period that may last several years, during which time they cannot be sold. Once vested, the RSUs are just like any other shares of company stock.
  • Unlike stock options or warrants which may expire worthless, RSUs will always have some value based on the underlying shares.
  • For tax purposes the entire value of vested RSUs must be included as ordinary income in the year of vesting.
  • RSUs are considered supplemental wages for tax purposes and income taxes are withheld at a flat rate of 22%. If your annual income exceeds $1Million, the withholding rates jumps to 37%.

RSUs give an employee an incentive to stay with a company for the long term and help it perform well so that their shares increase in value.

  • If an employee decides to hold their shares until they receive the full vested allocation, and the company's stock rises, the employee receives the capital gain minus the value of the shares withheld for income taxes and the amount due in to pay the taxes
  • RSUs don't provide dividends, as actual shares are not allocated.
  • An employer may pay dividend equivalents that can be moved into an escrow account to help offset withholding taxes or be reinvested through the purchase of additional shares.
  • The taxation of restricted stocks is governed by Section 1244 of the Internal Revenue Code for a Small Corporation.
  • Restricted stock is included in gross income for tax purposes, and it is recognized on the date when the stocks become transferrable.
  • RSUs aren't eligible for the Internal Revenue Code (IRC) 83(b) Election, which allows an employee to pay tax before vesting, as the Internal Revenue Service (IRS) doesn't consider them tangible property.

RSUs don't have voting rights until actual shares get issued to an employee at vesting. If an employee leaves before the conclusion of their vesting schedule, they forfeit the remaining shares to the company.



Restricted stock are shares that have been granted to an executive. The shares are nontransferable and subject to forfeiture under certain conditions, such as termination of employment or failure to meet either corporate or personal performance benchmarks. The restricted stock also generally becomes available to the recipient under a graded vesting schedule that lasts for several years.

Although there are some exceptions, most-restricted stock is granted to executives who are considered to have "insider" knowledge of a corporation, thus making it subject to the insider trading regulations under SEC Rule 144.  Failure to adhere to these regulations can also result in forfeiture. Restricted stockholders have voting rights the same as any other type of shareholder.

Restricted stock usually becomes taxable upon the completion of the vesting schedule. For restricted stock plans, the entire amount of the vested stock must be counted as ordinary income in the year of vesting and is taxed as ordinary income.

Shareholders of restricted stock can report the fair market value of their shares as ordinary income on the date that they are granted, instead of when they become vested if they so desire, i.e., an 83(b) Election in some instances. This may be a good way to manage the taxes associated with the Grant of the Restricted Stock and subsequent vesting.


A Section 83(b) Election tells the Internal Revenue Service (IRS) that you want to report income and the associated tax in the year your stock was granted instead of when it is vested. This means you will report income at the current stock price when the stock is granted to you instead of the stock price the year the stock vests.

The Benefit of Vesting

One of the primary purposes of an equity grant is to encourage founders and new employees to stay with the company for as long as possible.  Simply giving out stock free and clear defeats that purpose, because a founder or employee has no incentive to stick around.

This is why most if not all equity grants come with vesting provisions, in which rights in the stock vest over time.

The 83(b) Election:

Under Section 83(b), the employee is permitted to make a so-called “Section 83(b) election.” If the election is made, the employee will be required to recognize as income the fair market value of all the granted shares as of the date of grant, rather than the date of vesting.

For example, the fair market value of the 10,000 shares on the date of grant is $0.50 per share, and the resulting income is $5,000.  With an effective federal income tax rate of 30%, the employee will pay a total of $1,500 in federal income tax as a result of the grant and Section 83(b) election.

By taking the 83(b) election, the employee has essentially decided to pay more in taxes up front based on the hope that the value of the stock will rise significantly during the vesting period, which would result in an overall tax savings.  Thanks to the 83(b) election, the annual vesting will not be treated as taxable events, and when the stock is sold, any appreciation since the grant date will be taxed as a capital gain as opposed to ordinary income.

The Downside:

Once it’s taken, the 83(b) election is irrevocable. If an employee makes the election and pays full tax on the shares as of the date they’re granted, and he quits or is fired during the vesting period, he forfeits all of his unvested shares, and will not be entitled to get a refund of any tax paid.  Another risk when dealing with a startup is the very real chance that it may not succeed.  If the company goes under after a year or two, you’ve paid tax on stock that is now worthless.  

How to Make the Election

Employees desiring to take a Section 83(b) election must do so within 30 days of the grant.  Failure to do so waives the election, employees must always keep that strict deadline in mind.  

To file the election, one need only complete the Section 83(b) election form and mail it to the IRS within 30 days after the equity is granted.



Now that we have covered the various components of Workplace Wealth, we need to develop a plan to maximize the benefits from the various ownership shares, options and grants and deferred compensation we have earned.

We should set up an overview of all the components and arrange them in chronological order of vesting and expiration.

The options and grants we have earned or are in the process of vesting can be the starting point.

  • Option vesting schedule
  • Grant vesting schedule
  • Restriction schedules
  • Deferred compensation which we will need to take after we leave employment

Forecast the timing and amount of various items becoming available as income.

Create a plan to ensure we act on these opportunities and minimize the tax impact as we are doing so.

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Tailoring Stratagies to Manage Your Financial Future

Securities offered through LPL Financial, Member FINRA and SIPC.  Investment advice offered through U.S. Financial Advisors, a registered investment advisor.  U.S. Financial Advisors, U.S. Wealth Management and U.S. Wealth Farmington Valley are separate entities from LPL Financial