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"We want to give our team equity."
Right instinct. But "equity" covers three very different instruments. Each has its own tax treatment, admin requirements, and practical traps.
Pick the wrong one at the wrong stage and your employees pay real money for it.
Restricted stock: buying shares early
A restricted stock award is a sale of actual shares. The recipient pays the purchase price, typically fair market value. The shares vest over time. Leave early and the company repurchases unvested shares at the original price.
The critical step: File an 83(b) election within 30 days. This tells the IRS to tax the recipient now, at the current low value. Without it, tax hits at each vesting date at ordinary income rates.
When it works best:
- Very early stage, when FMV is close to zero
- The recipient can afford the purchase price
- You want QSBS and capital gains clocks to start immediately
The risk: Skip the 83(b) and the math changes fast. A $1,000 stock purchase at founding could trigger six figures in vesting-date taxes four years later.
Stock bonuses: shares without a price tag
A stock bonus grants shares with no purchase price. It can vest over time or be fully vested at grant.
Like restricted stock, unvested stock bonuses qualify for the 83(b) election. If FMV is low at grant, the recipient files the 83(b) and pays minimal tax.
When it works best:
- The employee cannot afford to purchase shares
- FMV is still low enough that the 83(b) tax is manageable
- You want to grant fewer shares at full value
The catch: Even though the employee pays nothing, the company must report the value as compensation income. Withholding and W-2 or 1099 reporting apply.
RSUs: the promise of future shares
RSUs are a right to receive shares later, typically at vesting. No purchase price. No shares issued until settlement. Tax hits at delivery, at ordinary income rates, on the full FMV.
For public companies, RSUs work. Employees sell enough shares to cover taxes. The system runs on liquidity.
For private companies, RSUs create a problem. Tax is due at vesting. There is no market to sell shares. The employee owes cash on paper gains.
The common fix: Add a liquidity event trigger. Shares settle only when both time vesting and a qualifying event (IPO, acquisition) are satisfied. This defers tax until cash is available.
The 409A trap: If the liquidity event is not "substantially uncertain" under 409A, the employee faces a 20% penalty tax. Even without receiving any shares.
When it works best:
- Later stage, when FMV is too high to purchase
- Liquidity is expected within a reasonable timeframe
- You are competing with public companies for talent
How to choose
Very early stage (near-zero FMV): Restricted stock or stock bonus with 83(b). Tax is negligible. Capital gains and QSBS clocks start immediately.
Growth stage (meaningful FMV, no liquidity): The hardest stage. Options (ISOs or NSOs) are often the better fit. Stock bonuses with 83(b) may work if FMV is still manageable.
Late stage or pre-IPO (high FMV, liquidity expected): RSUs. Tax at settlement is offset by the ability to sell. Fewer shares needed because they are full-value.
The bottom line
Equity is one of the most powerful tools for building a team. But the instrument has to match the stage.
Defaulting to RSUs because big tech uses them can cost early-stage employees tens of thousands in unnecessary taxes. Get the structure right early.
We help founders design equity programs that fit their stage and their team's tax situation. If you are setting up or rethinking your equity plan, reach out at Fellow.
