What Happens to Unvested Stock When You Get Laid Off?

When an employee faces a layoff, questions about their compensation often arise, particularly concerning equity such as stock. Many individuals receive company stock or options as part of their overall compensation package, which can become a significant component of their financial outlook. However, the exact treatment of this equity upon job termination can be a source of confusion and uncertainty. This article aims to clarify what happens to unvested stock when an employee is laid off, providing insights into the default outcomes, the importance of reviewing documentation, and the subsequent actions and tax considerations.

Understanding Equity Compensation and Vesting

Equity compensation is a non-cash remuneration, often involving company shares or the right to acquire shares, designed to align employee interests with the company’s success. Companies use equity to attract and retain talent, especially in competitive industries or for startups with limited cash for high salaries.

“Unvested stock” refers to equity compensation granted to an employee but not yet fully transferred into their ownership. Full ownership is conditional upon meeting specific criteria, most commonly continued employment over a defined period or the achievement of certain performance milestones. Until these conditions are met, the shares remain under the company’s control, and the employee does not have full rights to them, such as the ability to sell or transfer.

“Vesting” is the process through which an employee gains complete ownership of their equity award over time by fulfilling predetermined conditions. A “vesting schedule” outlines when and how much of the equity becomes owned. Common schedules include “cliff vesting,” where a significant portion vests all at once after an initial waiting period (e.g., one year). “Graded vesting” allows employees to gain ownership incrementally over the entire vesting period, such as a percentage vesting quarterly or annually.

Several common types of equity compensation can be subject to vesting. Restricted Stock Units (RSUs) represent a promise from the employer to deliver shares or their cash equivalent once vesting conditions are satisfied. Stock options, including Incentive Stock Options (ISOs) and Non-Qualified Stock Options (NSOs), grant the right, but not the obligation, to purchase company shares at a preset price (strike price) once they vest. Employee Stock Purchase Plans (ESPPs) enable employees to buy company stock, often at a discount, through payroll deductions, with shares sometimes subject to holding periods before full ownership.

Default Treatment of Unvested Equity Upon Layoff

Unvested equity compensation is forfeited when an employee’s job is terminated, including in a layoff. This occurs because the underlying vesting conditions, which require ongoing employment, are no longer met. The company reclaims these unvested shares, and the former employee loses any claim to them.

For unvested Restricted Stock Units (RSUs), the outcome upon layoff is straightforward: they are canceled. The employee loses the right to receive those shares, and no shares or cash equivalent are issued for the unvested portion.

Unvested stock options, whether Incentive Stock Options (ISOs) or Non-Qualified Stock Options (NSOs), are also forfeited upon termination. The right to purchase shares at the predetermined strike price for those unvested options is rescinded. Vested but unexercised options may have a limited window for exercise after termination, a topic addressed later.

Employee Stock Purchase Plans (ESPPs) have rules regarding unvested shares or contributions upon layoff. If an employee has been making payroll deductions toward an ESPP purchase that has not yet occurred, contributions are returned. If shares have been purchased but are still subject to a holding or vesting period, they may be subject to forfeiture or buyback rules outlined in the plan document.

While forfeiture is the rule, some companies may have provisions for accelerated vesting in specific circumstances. These exceptions are rare and detailed within the company’s equity plan documents or individual grant agreements. Accelerated vesting might occur in scenarios such as a change of control or as part of a severance package, depending on the specific terms established by the employer.

Navigating Company Policies and Grant Agreements

The answers regarding the treatment of unvested equity upon layoff are contained within an employee’s specific agreements and the company’s equity plans. General rules provide a baseline understanding, but individual circumstances are governed by these legal documents. Reviewing these materials is an important step for any employee facing a layoff.

Several documents provide the necessary information. The “Equity Grant Agreement” for each RSU or stock option grant is the primary document, detailing vesting schedules, outlining what happens upon various types of termination (including layoffs), and specifying any post-termination exercise windows for vested options. This document often includes clauses addressing forfeiture, acceleration, and other important terms.

Beyond individual grant agreements, the “Equity Plan Document” governs all equity awards and may contain rules, definitions, and administrative procedures. An employee’s “Employment Contract” or “Offer Letter” might also include provisions related to equity treatment upon termination, especially for senior roles. If a severance package is offered, the “Severance Agreement” could modify the default equity treatment, potentially including terms for accelerated vesting or extended exercise periods.

When reviewing these documents, employees should look for clauses related to “Termination for Cause” versus “Termination Without Cause.” Layoffs fall under “without cause” or “involuntary termination,” which triggers different equity treatment than termination for performance or misconduct. Clauses concerning “Vesting Acceleration,” especially those tied to involuntary termination or a change of control, are also relevant. Understanding the “Post-Termination Exercise Period” for any vested options is key, as this dictates the timeframe within which an employee can act on those options.

Employees can access these documents through their company’s human resources portal, the website of their equity plan administrator (e.g., Fidelity, Schwab, Carta), or by requesting them from their HR department or legal team. A review of these documents will provide clarity on the terms applicable to their situation, allowing them to understand their rights and obligations concerning their equity compensation.

Post-Layoff Actions and Tax Considerations

Once an employee understands the fate of their unvested stock and their vested equity, certain actions and tax considerations become relevant. For any unvested stock confirmed to be forfeited, no further action is required from the former employee regarding that portion. This equity reverts to the company as per the terms of the grant agreement.

For any stock options vested at the time of layoff, or those that vested due to an acceleration clause, a key action is to exercise them within the specified post-termination exercise window. This period is limited, ranging from 30 to 90 days, but it can vary depending on the company’s plan. Failing to exercise within this window will result in the forfeiture of even these vested options. The decision to exercise should consider factors such as the difference between the strike price and the current market price, financial liquidity, and outlook on the company’s future performance.

Exercising stock options triggers tax implications. For Non-Qualified Stock Options (NSOs), the difference between the fair market value of the shares on the exercise date and the strike price (the “bargain element”) is taxed as ordinary income. This amount is included in the employee’s W-2 wages, and the company may withhold taxes at exercise. Incentive Stock Options (ISOs) have a different tax treatment; no regular income tax is due at exercise. However, the “bargain element” of ISOs may be subject to the Alternative Minimum Tax (AMT) in the year of exercise for higher-income taxpayers.

After shares are acquired, either through RSU vesting or stock option exercise, their sale triggers capital gains or losses. The gain or loss is calculated based on the difference between the sale price and the cost basis. If shares are held for one year or less from the date of exercise (for options) or vesting (for RSUs), any profit is taxed as short-term capital gains, at ordinary income tax rates. If held for more than one year, profits are taxed as long-term capital gains, which benefit from lower tax rates.

Given the complexities of equity compensation and tax regulations, consulting with a qualified financial advisor or tax professional is recommended. These professionals can provide personalized guidance based on individual financial circumstances and the terms of the equity awards, helping to navigate decisions related to exercising options and managing tax liabilities.