From AMT To VCD: A Guide To The Many Abbreviations Of Stock Compensation

Do you know NQSOs from ISOs? AMT from FICA and NIIT? What’s the FMV at option exercise? What's the PTEP if you lose your job? What would happen to your grants in a CIC? Can you sell company stock when you know MNPI? What’s the deal with RSUs, PSUs, ESPPs, and SARs? 

Stock options, restricted stock units, and employee stock purchase plans come with a confusing jumble of acronyms, initialisms, and jargon. Learning these abbreviations is a good way to become familiar with some of the key features and details of stock compensation—and given how long and cumbersome some of the underlying terms are, you’ll soon learn to appreciate their brevity.

This article provides a handy guide, organized by topic.

WYSIWYG: Types Of Grants

SBC: stock-based compensation, pay that involves company stock rather than cash.

ESO: employee stock option, a right that a company awards to purchase a specific number of its shares for a specified price (exercise price) and period (often up to 10 years). Employee stock options are different from listed or exchange-traded options.

NQSO or NSO: nonqualified stock option, the basic and most common type of ESO. NQSOs do not qualify for special tax treatment under the Internal Revenue Code (IRC).

ISO: incentive stock option, the other major type of stock option. An incentive stock option is a type of ESO that qualifies for special tax treatment under the IRC if certain requirements and holding periods are met.

RSU: restricted stock unit, the most common type of equity award nowadays in public companies. A grant of RSUs is a promise to issue you a set number of shares after you’ve met the related vesting conditions, usually a specified length of continued employment or services. Restricted stock awards (RSAs) are similar to RSUs but have a few differences, such as being able to make an 83(b) election to pay taxes on the value of the shares at grant rather than at vesting.

PSU: performance share unit, a grant of shares that vests or pays out based on performance rather than just continued employment. Performance-based grants can be in the form of performance stock awards (PSAs), which are similar to restricted stock, or performance stock units (PSUs), which are similar to RSUs. The most common performance goal metrics are total shareholder return (TSR) and relative total shareholder return (rTSR).

ESPP: employee stock purchase plan, a type of broad-based stock plan that permits employees to use payroll deductions accumulated over a purchase period (e.g. one, three, six, twelve months) to acquire stock from the company, often at a discount or at least without commission.

SAR: stock appreciation right, a contractual right that lets you receive cash or stock equal in value to the appreciation of a specified number of company shares between the grant date and the exercise date. The taxation of SARs is similar to that of NQSOs.

LTI: long-term incentive, a formal name for stock and cash compensation that is earned based on a time horizon, performance goal, or vesting period of more than one year, by contrast with short-term incentives (e.g. an annual cash bonus).

OMG: Taxes

OI: ordinary income. Salary, wages, interest, and types of income taxed at ordinary tax rates. Most forms of stock compensation generate ordinary income, and tax withholding applies.

CG: capital gain, income that arises from the sale of a capital asset, such as the sale of shares acquired from your equity comp. Capital gains and losses may be short-term (held 12 months or less) or long-term (held longer than 12 months). Short-term capital gains (STCG) are taxed at the rates of ordinary income. Long-term capital gains (LTCG) are taxed at 0%, 15%, or 20%, depending on your taxable income during the year.

AMT: alternative minimum tax. The alternative minimum tax system runs parallel to ordinary income tax. Under the AMT system, your alternative minimum taxable income (AMTI) is similar in concept to adjusted gross income (AGI) for ordinary income tax. When you exercise ISOs and hold the shares beyond the calendar year of exercise, the spread is part of your AMTI and you can trigger the AMT, depending on a number of other factors.

FICA: Federal Insurance Contributions Act. Together, Social Security and Medicare taxes are called FICA taxes because they are collected under the authority of the Federal Insurance Contributions Act. You know them from your paycheck and the Form W-2 you use for your tax returns. FICA taxes, also know as the federal payroll taxes, apply when you exercise NQSOs or SARs and at the vesting of restricted stock and RSUs.

FMV: fair market value. The FMV of a company’s stock is used to determine the amount of taxable income to report for an exercise of NQSOs and SARs and for the vesting of restricted stock/RSUs. The FMV is also used to set the exercise price of stock options on the grant date.

IRC: The Internal Revenue Code, possibly the most complex tax system in human history, is the body of legislation that governs all federal taxation in the United States, including the taxes that apply to stock compensation. For example, IRC Section 422 governs the taxation of ISOs, while Section 423 sets the rules for tax-qualified ESPPs.

NIIT: Net Investment Income Tax, a 3.8% Medicare surtax on investment income, such as capital gains and dividends, when your income is over specified threshold amounts. This extra 3.8% tax applies on top of the usual capital gains tax (15% or 20%, depending on income) for taxpayers with yearly modified adjusted gross income (MAGI) of more than $200,000 (more than $250,000 for married joint filers).

FITW: federal income-tax withholding, which applies at the exercise of NQSOs and SARs and the vesting of restricted stock and RSUs.

QSBS: Qualified Small Business Stock. Stock in a startup company that allows you, under certain conditions, to sell shares held more than five years at a 0% capital gains rate. There are detailed rules that determine whether the new company’s stock, and your stock, is QSBS.

SRF: substantial risk of forfeiture, a tax term that applies when rights to compensation are conditioned upon future services (e.g. working X years for a company) or certain targets (e.g. reaching a performance goal or stock price). If the condition is not satisfied, the stock is forfeited. In the context of restricted stock and RSUs, income is not recognized while the stock is still subject to risk of forfeiture (i.e. must vest).

BTW: Other Abbreviations

PTEP: post-termination exercise period, the length of time you have to exercise stock options after your employment at the company ends. This period is almost always shorter than the term that would remain if your employment had continued. It usually lasts 90 days from the termination date, but it can be much less, and if you miss the exercise window you cannot get the options back. See your stock plan and grant agreement for details, including what happens with a leave of absence (LOA).

BSM: Black-Scholes model, a complex mathematical formula used to calculate the theoretical present value of a stock option using variables such as stock price, exercise price, volatility, and expected option term (i.e. the time until exercise). Black-Scholes is the option-valuation model most commonly used in accounting for stock options and in certain financial-planning tools.

CIC: change in control. This denotes a merger or acquisition or other substantial change in shareholder ownership of a company. A change in control can trigger the acceleration of vesting in stock options, restricted stock, and RSUs. The specifics of what constitutes a change in control and its impact are defined in your company’s stock plan documents.

SDS: same-day sale. In this type of option exercise, the immediate sale of the underlying shares from the exercise generates the proceeds to pay the exercise price and any tax withholding. This is also called a cashless exercise.

STC: sell-to-cover. In this type of option exercise you sell just enough of the stock to “cover” the total exercise costs (exercise price + taxes), with the remaining stock held. With restricted stock/RSUs, this applies to selling shares at vesting to cover the tax withholding.

GTC: good-till-canceled order. This is an order to sell stock associated with an exercise when the stock reaches a specific price while the order remains open. To prevent sales of its stock from occurring outside authorized trading windows, some companies do not allow this.

IPO: initial public offering, the process in which a privately held company first offers its shares to the investing public, usually through a registration statement under the securities laws. An IPO is what brings a private company into the stock market as a public company.

SEC: Securities and Exchange Commission, the US federal government agency responsible for the supervision and regulation of the securities industry, the stock markets, securities offerings, and the ongoing disclosure obligations of public companies in the United States. SEC rules and regulations affect many aspects of equity compensation and stock ownership.

MNPI: material nonpublic information, confidential information that will move the company’s stock price (whether up or down) when it is made public. Buying or selling stock when you know material nonpublic information is insider trading, which is illegal, along with insider tipping. To avoid getting into trouble for insider trading, refrain from trading company stock when you know MNPI.

VCD: vesting commencement date, used in some stock plans to note the start of a grant's vesting period.

GTK: Further Resources

Hopefully the wealth your equity comp or ESPP creates will give you lots of WAFF. If you need it (you will), the glossary of stock compensation terms at myStockOptions.com has nearly 1,000 detailed definitions of stock comp terms and phrases. The glossary is also available as a smartphone app: Stock Compensation Glossary, available free from the App Store (Apple devices) and from Google Play. It includes a “term of the day” and a handy quiz.

In addition, our website has an interactive quiz on stock comp abbreviations where you can test your knowledge.

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WEBINAR: Stock Option Exercise Strategies: Managing Risk & Building Wealth (June 15)

The next webinar at the myStockOptions Webinar Channel is coming up on June 15:

Stock Option Exercise Strategies: Managing Risk & Building Wealth
2:00pm to 3:40pm ET (11:00am to 12:40pm PT)

In 100 minutes, three leading financial experts will provide up-to-the-moment practical guidance for stock options in both public and private companies, including real-world case studies. Volatile stock markets and widespread layoffs in the tech industry make the need for effective guidance even more important, as this webinar will cover.

The webinar offers 2.0 CE credits for CFP, CPWA/CIMA, CEP/ECA, CPE (live webinar only), and EA (live webinar only).

After the live webinar, the webinar recording will be available in on-demand format both to registered webinar attendees and to those who later purchase streaming access.

Financial Literacy With Stock Options, RSUs, And ESPPs: 7 Key Lessons

Financial literacy is all the rage now. In fact, April was National Financial Literacy Month! With the growing complexity of many financial instruments, financial literacy is more important than ever.

For most employees, few financial endeavors are more complex than understanding stock options, restricted stock, restricted stock units (RSUs), employee stock purchase plans (ESPPs), and other forms of stock compensation. These valuable forms of compensation can make a big difference in achieving both short-term and long-term life goals, such as boosting cash flow, funding college, buying a house, or saving for retirement. But they can also be tricky. Pitfalls await the unwary.

Below are seven ways you can improve your fluency with stock compensation. Before you start, be sure you gather and review all of your stock-plan-related documents, including the grant agreement, the grant notice, the stock plan itself, and any company communications about these.

1. Set Goals

All financial planning starts with setting goals. What do you want to do with the proceeds from the eventual sale of shares acquired from stock options, restricted stock/RSUs, or an ESPP?

Having a purpose motivates you to improve your financial literacy. A clear understanding of how stock comp fits into your life will strengthen your incentive to understand all the complicated details.

Coming up with concrete goals will also help to clarify your use of the shares in relation to your salary, cash bonus, and 401(k) holdings and other savings.

2. Know What Type Of Equity Award(s) You Have

Many financial advisors I’ve spoken with have clients who initially tell them they have stock options when it turns out they have restricted stock units—which work very differently. While in popular parlance stock options has become a generic term for all types of equity compensation, you need to know the difference between actual stock options and other grant types.

Employee stock options give you the right to purchase a specified number of shares of the company’s stock at a fixed price during a rigidly defined timeframe.

Alert: Know your company’s procedures for accepting grants and exercising options. Exercise often involves a third-party website, such as that of the broker it designates.

Companies can grant two types of options: nonqualified stock options (NQSOs), the more common variety, and incentive stock options (ISOs). Before exploring the differences between NQSOs and ISOs, you must check your grant notice to know which type of options you have. ISOs have tax advantages and complexities, as explained in #3 below.

Restricted stock and restricted stock units (RSUs) are grants of company stock that you get outright once they vest. Usually, you don’t pay anything for shares granted by a public company.

Restricted stock and RSUs differ in a few ways. Restricted stock is issued at the time of grant and is held in escrow. You can’t sell or otherwise transfer the stock until vesting occurs. By contrast, RSUs are technically an unfunded promise to issue you shares when the vesting period has been satisfied. The shares are then “delivered” to you. RSUs are simpler for companies to administer, and in public companies RSU grants are much more common than grants of restricted stock.

3. Understand The Core Tax Treatment

With nonqualified stock options, at the time of option exercise you pay withholding taxes (federal income tax, any state income tax, Social Security up to the yearly maximum, Medicare). After that, any gains above stock price at exercise (i.e. your cost basis) follow the capital gains tax rules.

Incentive stock options qualify for special tax treatment under the Internal Revenue Code. You do not have any Social Security or Medicare tax and no income tax withholding, even if you sell the shares immediately.

Should you decide to hold ISO shares for more than two years from the date of grant and one year from the date of exercise, all appreciation over the exercise price is taxed at the lower long-term capital gains rates (i.e. none of the gain is taxed at ordinary income rates). However, the exercise spread on shares acquired from ISOs and held beyond the calendar year of exercise can subject you to the alternative minimum tax (AMT) and additional tax-return reporting.

Alert: You should consult a qualified financial or tax advisor do an AMT calculation whenever you hold the ISOs shares at exercise. Do it again at calendar year-end to decide whether to sell the shares to avoid the AMT.

With RSUs, you pay taxes through withholding on the income recognized at vesting (federal income tax, any state income tax, Social Security up to the yearly maximum, Medicare). When you sell the shares, any gain or loss above the compensation income you recognized (i.e. your cost basis) is taxed under the capital gains rules.

Alert: Compare the withholding rates your company uses for your stock compensation income to your marginal tax rate. If the withholding rate is lower and thus won’t cover all the taxes you owe, consider putting money aside to pay the taxes with your tax return or the need to pay estimated taxes.

OI = ordinary income tax (income and any withholding reported on Form W-2)
CG = capital gains tax (reporting on Form 8949 and Schedule D of tax return, even for capital losses or just commissions/fees)
AMT = alternative minimum tax
FICA = Social Security up to yearly maximum, plus Medicare
* Depends on when shares are sold, and on the price at sale relative to the price at exercise/purchase.
** Assumes shares are delivered at vesting and not deferred. With proper deferral, OI is delayed until later.

4. Identify The Vesting Schedule Of Stock Options, Restricted Stock, And RSUs

The vesting schedule of your grant dictates when you may exercise stock options, when forfeiture restrictions lapse on restricted stock, or when shares are delivered with RSUs in the standard public company equity awards.

Alert: Each grant you receive has its own vesting schedule and other terms.

Vesting is usually based on continuing to provide services for the company over a specified period. A grant can be designed to vest all at once (e.g. after four years) or in pieces, called tranches (e.g. 20% of the grant every year for five years, or 25% of the grant the first year and monthly after that). Especially for executives, the vesting schedule can also or instead be performance-based (e.g. tied to company-specific or stock-market targets, such as total shareholder return).

Once stock options have vested, you can exercise them—but you don’t have forever to do so. Stock options have a fixed term, usually ten years. At the end of the option term, any unexercised stock options expire and you have no way to get them back. Therefore, if your options have a ten-year term and are fully vested after four years, you will have six years during which to exercise them, assuming you keep working for the company (you will have less time to exercise options after job termination, as explained in #6 below).

5. Learn How Your ESPP Works

Employee stock purchase plans (ESPPs) are a type of stock-related company benefit in which your company deducts money from your paycheck to buy shares of its stock, often at a discount. ESPPs have their own key dates and rules to know, especially regarding enrollment to participate in the plan and how to change your contributions. During an ESPP purchase period, payroll deductions are accumulated. Shares are typically bought on the purchase date at the end of the period.

Alert: If your company has an ESPP, it can be a great deal. It’s vital that you know how and when to enroll and to later make any changes you may want.

There are two types of ESPPs: tax-qualified and nonqualified.

Tax-qualified ESPPs (also called Section 423 ESPPs for the tax-code section that sets the rules) let you buy shares at a specified discount of up to 15% from the stock price. Some companies use a lookback provision that bases the discount calculation on the stock price at either the start of the offering or end of the purchase period, whichever is lower. The IRS lets you buy up to $25,000 in shares during any calendar year, based on the price at the start of the offering, though your company may impose a lower limit.

You have no Social Security or Medicare tax and no income tax withholding at all. The sale (not the purchase) triggers taxes. If you hold the shares long enough to meet the holding periods (more than one year from purchase and two years from enrollment) for favorable tax treatment, most of your gain is taxed as long-term capital gain when you sell the shares.

Nonqualified ESPPs work in the same way but without the IRS rules and favorable tax treatment of qualified plans. A discounted price or contribution match (if any) produces ordinary income at purchase.

OI = ordinary income tax (income and any withholding reported on Form W-2)
CG = capital gains tax (reporting on Form 8949 and Schedule D of tax return, even for capital losses or just commissions/fees)
FICA = Social Security up to yearly maximum, plus Medicare
* Depends on when shares are sold, and on the price at sale relative to the price at purchase

6. Study What Will Happen If You Lose Your Job

Read your stock plan documents and your grant agreement carefully to know your rights if you are fired or if you quit, work for a competitor, retire, become disabled, or die. Make sure you, as well as your family or close friends, are aware of these rights.

With stock options, many plans give you no more than 90 days to exercise vested options after job termination, though the post-termination exercise period can be longer for certain life situations. However, you may lose vested options immediately if you leave the company to work for a direct competitor.

With restricted stock and RSUs, job termination almost always stops vesting and causes the forfeiture of unvested grants—you lose shares that have not yet vested. You keep any shares that vested before your termination date.

Exceptions can occur to accelerate vesting or let it continue, depending on the terms of your grant agreement or stock plan, such as special provisions for disability or death, for retirement, or for a change in corporate control (e.g. a merger or acquisition), or in a broad layoff.

Alert: If you are planning to leave your job soon, you may want to stick around long enough to get any valuable equity grants that may vest in the near future.

For more details on this topic, see my Forbes.com article Protect Your Stock Options And RSUs In Job Loss: 3 Key Actions.

7. Keep A Stock Comp Checklist

One good way to start with your stock compensation is to be sure you know the answers to the questions in a checklist you prepare. Questions on it may include:

1. What is the vesting period of stock options or restricted stock/RSUs?

2. How do I enroll in my company’s ESPP and make any changes in contribution amounts?

3.  With stock options, how long do I have before the grant expires?

4. What would happen to my grant if I were to leave or lose my job, die, become disabled, or retire? How do these events affect vesting and the forfeiture of the grant?

5. What are my goals for the income that I will receive from my stock compensation and/or ESPP? Do I want to use the gains for near-term goals (e.g. college tuition, downpayment for a house purchase) or for long-term goals (e.g. retirement)?

myStockOptions.com can help you with all aspects of stock compensation and ESPPs, from the basics to tax reporting and financial-planning strategies. Our resources include calculators and modeling tools, videos, and interactive quizzes to test your financial fluency with stock options, restricted stock/RSUs, and ESPPs. If you want personal guidance, seek the counsel of a qualified financial or tax advisor.

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WEBINAR: Stock Comp Bootcamp For Financial Advisors (May 3)

The next webinar at the myStockOptions Webinar Channel is coming up on May 3: Stock Comp Bootcamp For Financial Advisors (1pm to 2:40pm ET, 10am to 11:40am PT). Whether you are new to stock comp or want to sharpen your knowledge, this webinar will provide practical info and insights to maximize your success. All the essential topics will be presented in 100 lively minutes by Bruce Brumberg, the editor-in-chief and co-founder of myStockOptions and a Forbes contributor.

The webinar offers 2.0 CE credits for CFP, CPWA/CIMA, CEP, CPE (live webinar only), and EA (live webinar only).

After the live webinar, the webinar recording will be available in on-demand format both to registered webinar attendees and to those who later purchase streaming access.