When you take an executive job through a company, you may have some choice in the way that your earnings are payed out. Aside from a cash salary, some companies may offer stock options as a part of your compensation package. These stock options are generally considered part of your salary.
When a company offers stock options in lieu of more cash for a position, this is known as equity compensation. Most employees of a company do not get this offer. Equity compensation, including stock options, is generally reserved for high-level executives and the distribution of these stock options is determined by the company’s board of directors. In some instances, if a company wants to hire a candidate, they may provide the new employee a choice between the stock options and upfront pay.
If an employee receives stock options as part of a compensation package, those stocks remain in shares until the employee chooses to sell them. The employee may not sell any of the shares, however, until the stock is fully vested. For the stock to be vested, the employee must successfully adhere to the prearranged conditions set forth in the equity compensation agreement. Generally, this requires a certain length of employment with the company.
Even if a stock is in share form, and regardless of whether it is fully vested or not, the stock usually provides some additional income to an employee. If the company pays out quarterly dividends, the employee receives dividends from his or her shares of stock just like any other shareholders. The amount of those dividends is usually based on the amount of vested stock, which means payouts increase over time.
Even though stock options granted by an employer do not provide upfront pay, they do still provide tax liabilities. If you receive any dividends from the stock options during a year, you must add that payouts to the yearly income that you report on your tax return. If the stock option is considered vested at the time that it is granted to you, you must include the entire value of the stock as part of your income for that year and pay the taxes on it, even though you don’t have it in cash form. If it is not vested, you must pay taxes on the amount of stock that becomes vested each year.