Equity Is Part of Your Compensation. Understand It.
If you work in tech, finance, or at any venture-backed company in North America, there’s a good chance part of your compensation comes in the form of equity. Stock options, RSUs, phantom equity, profit interests: these aren’t just line items on an offer letter. They can represent a significant portion of your total pay.
The problem is that most employees don’t understand their equity. They sign offer letters without knowing the difference between an ISO and an NSO. They don’t ask about the 409A valuation. They don’t model what their options are actually worth after taxes. And they don’t plan for AMT.
This guide covers the major equity compensation structures used in the US and Canada, the tax implications you need to understand, and the practical decisions you’ll face at every stage from grant to sale.
Types of Equity Compensation in the US
Incentive Stock Options (ISOs)
ISOs are the most tax-advantaged form of stock option available to US employees. They’re authorized under Section 422 of the Internal Revenue Code and are available only to employees (not contractors or advisors).
Here’s how they work: you receive the right to purchase shares at a fixed price (the exercise price or strike price), which is set at the fair market value on the date of grant. The options vest over time, normally on a four-year schedule with a one-year cliff.
The tax advantage: when you exercise ISOs, there’s no regular income tax due. You don’t pay anything to the IRS at exercise (with one major caveat, discussed in the AMT section below). If you hold the shares for at least one year after exercise AND at least two years after the grant date, the profit when you sell is taxed as long-term capital gains, currently 0%, 15%, or 20% depending on your income bracket.
ISO limitations:
- Only available to employees, not contractors
- Maximum of $100,000 in ISOs can vest in any calendar year (based on the exercise price at grant)
- Must be exercised within 90 days of leaving the company, or they convert to NSOs
- Must be exercised within 10 years of grant
- Subject to AMT at exercise
Non-Qualified Stock Options (NSOs)
NSOs are the more common type and can be granted to anyone: employees, contractors, advisors, board members. They’re simpler but less tax-advantaged than ISOs.
When you exercise NSOs, the difference between the exercise price and the fair market value at the time of exercise is taxed as ordinary income. This is called the “bargain element” or “spread.” You pay income tax, Social Security tax (up to the wage base), and Medicare tax on this amount.
Your employer reports the spread as W-2 income and withholds taxes accordingly. This can result in a significant tax bill at exercise, especially if the spread is large.
When you later sell the shares, any additional gain above the fair market value at exercise is taxed as capital gains (short-term if held less than a year, long-term if held more than a year).
Restricted Stock Units (RSUs)
RSUs are the dominant form of equity at large public tech companies like Google, Meta, Amazon, and Microsoft. They’re simpler than options because there’s no exercise price. You’re promised a certain number of shares that vest over time.
When RSUs vest, the shares are delivered to you and the fair market value on the vesting date is taxed as ordinary income. Your employer withholds taxes, usually by selling a portion of the shares (“sell to cover”).
RSUs have value as long as the stock price is above $0, which makes them lower-risk than options. With options, if the stock price drops below your exercise price, your options are “underwater” and worthless. RSUs don’t have this problem.
Common RSU vesting schedules:
- Standard: 25% per year over four years
- Google: 33% year one, then diminishing amounts
- Amazon: 5% year one, 15% year two, 40% each in years three and four (back-loaded)
Restricted Stock Awards (RSAs)
RSAs are actual shares granted to you upfront, subject to vesting restrictions. Unlike RSUs, you own the shares immediately but can’t sell them until they vest.
The tax advantage of RSAs comes from the 83(b) election. If you file an 83(b) election with the IRS within 30 days of receiving the shares, you pay income tax on the value of the shares at the time of grant. If you’re at an early-stage startup where the shares are worth pennies, this means paying very little tax upfront, and then all future appreciation is taxed as capital gains when you sell.
Miss the 83(b) deadline and you’re taxed on the full value at vesting, which could be dramatically higher.
The 83(b) election is not reversible. If you make the election and the company fails, you’ve paid tax on worthless shares with no recourse.
409A Valuations: What They Are and Why They Matter
Section 409A of the Internal Revenue Code requires private companies to determine the fair market value (FMV) of their common stock through an independent appraisal. This valuation sets the exercise price for stock options.
A 409A valuation is typically performed by a third-party valuation firm and is updated at least once per year or after a material event like a funding round.
Why this matters to you: the 409A valuation determines your exercise price. A lower 409A means a lower exercise price, which means more potential profit. 409A valuations at early-stage startups are typically much lower than the preferred share price that investors pay, because common shares have fewer rights and lower liquidation priority.
If the company grants options at a price below the 409A valuation, those options face severe tax penalties under Section 409A: a 20% additional tax plus interest. This is the company’s problem to manage, not yours, but it’s worth knowing.
How to Use the 409A in Your Evaluation
When you receive an option grant, ask for the current 409A valuation per share. Then calculate:
Potential value = (Number of options) x (Expected future share price - Exercise price)
The “expected future share price” is the hard part. If the company just raised at a $100M valuation and you have options at a $10M 409A-equivalent share price, your options have significant built-in upside. If the company raises future rounds at higher valuations, the gap between your exercise price and the share value grows.
But companies also fail. Down rounds happen. Liquidation preferences can eat into common shareholder value. Don’t treat your equity calculation as guaranteed income.
AMT: The Tax Trap Most People Don’t See Coming
The Alternative Minimum Tax is the biggest gotcha in ISO taxation. Here’s how it works.
When you exercise ISOs, you don’t owe regular income tax. But the spread (fair market value minus exercise price) at exercise is a “preference item” for AMT purposes. If the spread is large enough, it can trigger AMT liability, meaning you owe tax at exercise even though you haven’t sold anything.
This is how people end up with enormous tax bills on paper gains. During the dot-com era, employees exercised ISOs when their company’s stock was valued at $50 per share, creating a huge AMT liability. Then the stock crashed to $2 and they owed taxes on gains that no longer existed.
How to Manage AMT Risk
Know your AMT crossover point. This is the amount of ISO exercises you can do in a year without triggering AMT. A tax advisor can calculate this based on your income, deductions and state tax situation.
Consider exercising early. If you exercise ISOs shortly after grant, when the spread between the exercise price and FMV is small, the AMT impact is minimal. Some employees exercise immediately after their cliff vests.
Don’t exercise and hold large amounts without professional advice. Exercising $500K worth of ISOs and holding the shares is a major financial decision. Get a CPA or tax advisor involved.
The AMT credit. If you pay AMT, you receive a credit that can offset regular taxes in future years. It’s a partial recovery, not a full one and it can take years to fully reclaim.
Vesting Schedules Explained
The Standard Four-Year Vest With One-Year Cliff
The most common vesting schedule in North America:
- Year 0-1: Nothing vests. This is the cliff period. If you leave before the one-year mark, you get zero equity.
- Year 1: 25% of your total grant vests on your one-year anniversary.
- Years 1-4: The remaining 75% vests monthly (or quarterly) over the next three years.
After four years, you’re fully vested.
Acceleration Clauses
Single-trigger acceleration: All unvested equity vests immediately upon a change of control (the company is acquired). This is rare in practice because acquirers don’t want to give the entire equity pool an immediate payout with no retention incentive.
Double-trigger acceleration: Unvested equity accelerates only if there’s both a change of control AND a qualifying termination (you’re laid off or your role is materially changed). This is more common and more reasonable.
If your offer letter doesn’t mention acceleration, you likely don’t have it. It’s worth asking about during negotiation, especially if you’re at a late-stage startup where an acquisition is plausible.
Post-Termination Exercise Period
When you leave a company, you typically have 90 days to exercise your vested options. After that, they expire.
Some companies offer extended exercise windows of 7 years or even 10 years. This is a significant benefit because it removes the pressure to come up with cash immediately after leaving. If the company is private, exercising means spending money on illiquid shares with uncertain value.
Ask about the exercise window during negotiations. A 10-year window is worth real money compared to a 90-day window.
Canadian ESOP Rules
Canada’s approach to stock options changed significantly with the 2019 and 2021 federal budgets.
Stock Option Deduction
Historically, Canadian employees could claim a 50% deduction on stock option benefits, effectively taxing them at half the rate of employment income. This made the effective tax rate on stock option gains closer to capital gains rates.
Starting in July 2021, the 50% deduction is limited to the first $200,000 per year in stock option benefits for employees of large, established companies. For employees of Canadian-Controlled Private Corporations (CCPCs) and companies with less than $500 million in annual revenue, the unlimited deduction still applies.
CCPC Stock Options
Options granted by CCPCs have especially favorable treatment. The taxable benefit is deferred until the shares are actually sold (not at exercise), and the full 50% deduction applies with no annual cap.
This makes CCPC options similar to US ISOs in their tax efficiency. You exercise and hold without immediate tax consequences, and when you sell, half the gain is effectively tax-free.
Employee Stock Purchase Plans (ESPPs)
Some Canadian employers offer ESPPs, which allow employees to purchase shares at a discount (typically 15% below market). The discount portion is taxed as employment income. Some plans qualify for the 50% deduction.
Capital Gains Inclusion Rate
As of 2024, the Canadian capital gains inclusion rate increased from 50% to 66.7% for gains above $250,000 per year for individuals. This affects the after-tax value of all equity compensation in Canada. If your stock option gains exceed $250,000 in a single year, the tax impact is more significant than it was historically.
How to Evaluate an Equity Package
Whether you’re in the US or Canada, here’s a framework for evaluating an equity offer.
Step 1: Get the Numbers
- Total number of shares/units granted
- Total shares outstanding (fully diluted)
- Current 409A or FMV per share
- Exercise price (for options)
- Vesting schedule and cliff
- Post-termination exercise window
Step 2: Calculate Your Ownership Percentage
Divide your shares by the total fully diluted share count. This is your ownership percentage. At a venture-backed company, early employees typically own 0.1% to 1%, with most individual contributors in the 0.01% to 0.1% range at later stages.
Step 3: Model Outcomes
Create three scenarios:
Modest exit: The company sells for 2x the current valuation. What’s your payout after exercise costs and taxes?
Strong exit: 5-10x the current valuation. Same calculation.
Failure: The company shuts down or sells for less than the liquidation preferences. Your equity is worth $0.
Weight these scenarios by probability. For a typical venture-backed company, the failure scenario is the most likely. According to data from CB Insights, about 70% of startups in the US and Canada fail. Of those that survive, most don’t return 10x.
Step 4: Consider the Tax Impact
For ISOs, model the AMT impact of exercise. For NSOs and RSUs, calculate the ordinary income tax at exercise/vesting. For Canadian options, apply the stock option deduction rules.
A $500K equity package that costs $200K in taxes is really a $300K package. Factor this in.
Step 5: Compare to Cash
Would you prefer $10K more in base salary or $40K in options? If the company has strong exit potential and you can afford the lower salary, options may be the right choice. If you need the cash for rent and student loans, take the salary.
Equity is compensation you will receive in the future, if things go well. Salary is compensation you definitely receive now.
Equity and Your Career Trajectory
Equity compensation has a meaningful impact on career decisions. It creates golden handcuffs (you stay to vest), it concentrates your financial risk in your employer (your salary AND your investment portfolio are tied to the same company) and it can create windfalls or disappointments that color how you think about future offers.
When listing equity experience on your resume, don’t include dollar amounts. You can note your participation in equity programs, particularly if you experienced a successful exit: “Participated in the company’s stock option program through its acquisition by [Acquirer].”
For more on understanding benefits and compensation in North American job markets, read our North American benefits and compensation guide.
If you’re preparing a resume for a role at a company that offers equity, 1Template can help you format your experience to show you understand startup compensation structures, which signals sophistication to equity-granting employers.
Equity can be life-changing money or it can be worth nothing. Understanding the mechanics is the difference between making informed career decisions and gambling on hope. Take the time to learn it. Ask the hard questions before you sign.
