Equity units are a contractual right to a slice of your company’s value, granted as part of your compensation and paid out only if you stay long enough to vest and the company reaches a sale, public offering, or other cash event. The label covers several very different instruments: restricted stock units at a corporation, membership interests or profits interests at an LLC, performance-based grants at either. What you actually own, what it can be worth, and how it will be taxed all depend on which type you were granted and what the paperwork says.
What Equity Units Are
An equity unit is a contractual right to a piece of the issuing company’s value. The rights attached to each unit are spelled out in the governing documents: a corporate stock plan, an LLC operating agreement, and your individual grant agreement. Companies issue equity units for two purposes: raising capital from investors, who usually negotiate preferential terms, and incentivizing employees, who usually receive a simpler stake that vests over time.
The word “unit” is deliberately broad. In a corporation it may represent a promise to deliver shares later. In an LLC or partnership it represents a membership interest with economic rights defined by the operating agreement. What matters is not the label but the specific rights your grant gives you: what triggers your payout, how the unit is valued, and what happens if you leave. Those answers live in the documents, not in the generic term.
The Main Types You’ll Encounter
The form of unit you’re offered depends mostly on how the company is organized.
- Restricted Stock Units (RSUs) are a promise to deliver shares of common stock, or the cash equivalent, once vesting conditions are met. You don’t own actual shares until settlement. RSUs are the standard equity compensation tool at public companies and many well-funded private corporations.
- Performance Share Units (PSUs) work like RSUs but vest only when the company hits specified performance targets. Miss the target and the units never vest.
- LLC Membership Units are direct ownership interests in a limited liability company, functioning like common stock. They entitle the holder to a share of profits and distributions as defined in the operating agreement.
- Profits Interests are a special class of LLC unit that gives the holder a share of future appreciation and profits, but not the company’s existing value. If the company were liquidated the day after your grant, you’d receive nothing. This structure carries major tax advantages at grant, which is why LLC-organized startups favor it.
How Vesting Works
Receiving a grant doesn’t mean you own the units. Vesting is the process of actually earning them, and until units vest they’re a revocable promise.
Time-Based Vesting
The dominant approach at private companies is a four-year schedule with a one-year cliff. You get nothing for the first twelve months. On your one-year anniversary, 25% of your total grant vests at once. The remaining 75% vests in equal monthly or quarterly installments over the next three years. Leave during that first year and you walk away with nothing.
The cliff protects the company from granting ownership to employees who leave quickly. For you, it means the first year carries all the risk. After that, equity accumulates steadily until you’re fully vested at year four.
Performance-Based Vesting
Some grants tie vesting to company milestones rather than dates: a revenue target, a specific funding round, a product launch. Performance vesting adds uncertainty because the timeline isn’t in your control. If the company misses its targets, the units may never vest no matter how long you stay.
Unvested units are forfeited when you leave, whether the vesting was time-based or performance-based. You get no compensation for them.
How RSUs Are Taxed
RSU taxation runs in two stages: ordinary income at vesting, then capital gains or losses when you sell.
When your RSUs vest and shares are delivered, the fair market value of those shares on the vesting date counts as ordinary income. It appears on your W-2 and is subject to federal and state income tax plus FICA.1Office of the Law Revision Counsel. 26 USC 83 – Property Transferred in Connection With Performance of Services Your employer withholds taxes at settlement, which is why the net share delivery is always smaller than the gross number that vested. For 2026, Social Security tax applies to earnings up to $184,500 at 6.2%, with Medicare tax of 1.45% on all earnings and no cap.2Social Security Administration. Contribution and Benefit Base
After vesting, your tax basis equals the fair market value on the vesting date. Any gain or loss when you sell is measured from that basis. Hold the shares more than a year after vesting and the gain qualifies for long-term capital gains rates, which top out at 20% for the highest earners in 2026.3Internal Revenue Service. Topic No. 409, Capital Gains and Losses Sell within a year and the gain is taxed at your ordinary income rate.
How Profits Interests Are Taxed
Profits interests follow completely different tax rules, and the stakes of handling them wrong are high. Under a safe harbor established in Revenue Procedure 93-27, as long as the interest would pay out nothing in a hypothetical immediate liquidation, receiving it is not a taxable event for you or the company.4Internal Revenue Service. Revenue Procedure 2001-43 The unit is worth zero at grant because it only covers future appreciation, so there’s no income to tax up front.
The 83(b) Election
The critical decision with a profits interest is whether to file an 83(b) election with the IRS within 30 days of the grant date.5Internal Revenue Service. Form 15620 Instructions This election tells the IRS you want to recognize the property’s value at transfer rather than at vesting.1Office of the Law Revision Counsel. 26 USC 83 – Property Transferred in Connection With Performance of Services Because a profits interest is worth zero or close to zero at grant, you’ll recognize little or no ordinary income. From that point forward, all future appreciation is taxed as long-term capital gain when you sell, provided you hold for more than a year after the grant date.
Skip the election and the math gets ugly. You’ll recognize ordinary income when the units vest, based on their fair market value at that later date. If the company has grown in the interim, you could face a substantial ordinary income tax bill on value you can’t yet sell. The 30-day deadline is absolute and cannot be extended.
The risk of filing an 83(b) is that you lock in a tax position on units that might never vest or end up worthless, and if you forfeit them you get no deduction. For most profits interest grants where the starting value is near zero, the downside is small and the potential savings are meaningful.
Phantom Income
Once you hold an LLC membership or profits interest, the IRS treats you as a partner. The LLC sends you a Schedule K-1 each year reporting your allocated share of taxable income, gains, losses, and deductions. You owe tax on that allocated income whether or not the company actually distributes any cash.
This is phantom income, and it can be a real financial burden. If the company is profitable but reinvesting all its cash into growth, you could owe thousands on income that exists only on paper. Some operating agreements include a “tax distribution” provision sending members enough cash to cover their liability. Not all do. Before accepting an LLC equity grant, check the operating agreement for tax distribution language. If it’s missing, budget for paying taxes out of pocket on income you never see.
Self-Employment Tax Reclassification
Holding an LLC interest can also change how the IRS classifies you. Under longstanding IRS guidance, members of an LLC taxed as a partnership cannot simultaneously be treated as employees of that LLC for employment tax purposes. If your profits interest makes you a partner, you may lose W-2 status and become subject to self-employment tax on your share of the LLC’s income. Self-employment tax covers both the employee and employer portions of Social Security and Medicare, totaling 15.3% on earnings up to the Social Security wage base.2Social Security Administration. Contribution and Benefit Base The consequences reach beyond the tax rate: you may lose access to employer benefits that require W-2 status.
What Your Units Are Actually Worth
The number on your offer letter is not what you’ll receive, and several structural factors sit between your grant and any eventual payout.
The Distribution Waterfall
When money flows out of an LLC, it doesn’t split evenly among all unit holders. The operating agreement typically establishes a distribution waterfall that determines who gets paid first. Capital investors usually get their initial investment returned before anyone else sees a dollar. Preferred unit holders often receive a guaranteed return next. Employee incentive units and profits interests sit further down the priority list. This matters enormously in a modest exit: if the sale price barely covers investor capital, your units may be worth nothing even though you technically own a percentage of the company.
Dilution
Every time the company raises a new round, it issues additional equity, expanding the total ownership pool and shrinking every existing holder’s percentage. If you own 1% at the seed stage and the company raises a Series A, B, C, and D, your ownership might drop to 0.4% without you selling anything. Each round ideally increases the total value of the company, so a smaller percentage of a larger pie can still be worth more. If a round prices flat or down, though, your units lose both percentage and value. Employee grants almost never include anti-dilution protection; that’s reserved for preferred investors.
Section 409A Valuation Risk
Section 409A of the Internal Revenue Code governs nonqualified deferred compensation. Any private company granting equity units needs to establish fair market value using a defensible methodology, typically through an independent appraisal known as a 409A valuation. This ensures options and units aren’t granted below market value, which the IRS treats as deferred compensation subject to 409A.
You don’t control whether the company gets this right, but you bear the consequences if it doesn’t. When compensation falls out of 409A compliance, the deferred amount becomes immediately taxable, and the IRS adds a 20% penalty tax on top of regular income tax. The statute also tacks on an interest charge at the underpayment rate plus one percentage point, running back to the year the compensation was first deferred or vested.6Office of the Law Revision Counsel. 26 USC 409A – Inclusion in Gross Income of Deferred Compensation Under Nonqualified Deferred Compensation Plans That penalty falls on the employee, not the company. Before accepting a grant, ask when the company last completed a 409A valuation and whether an independent appraiser performed it.
Transfer Restrictions and Limited Voting
You generally cannot sell, gift, or transfer equity units in a private company without consent. Employee units also rarely carry meaningful voting rights; the grant agreement usually limits or eliminates them, keeping control with founders and preferred investors. Your grant may also be subject to drag-along provisions that let majority owners force minority holders to participate in a company sale on the same terms.
Getting Paid: Liquidity Events
Vested units in a private company are worth nothing until they can be converted to cash or tradeable securities. You can’t open a brokerage app and sell. You need a liquidity event.
IPO
If the company goes public, vested units convert into shares of publicly traded stock. Employees are typically subject to a lock-up agreement that prevents selling immediately. Most lock-ups last 180 days after the offering date, though they can range from 90 to 180 days.7Investor.gov. Initial Public Offerings: Lockup Agreements During that window, you watch the stock price move but can’t act. Plenty of employees have watched a post-IPO price peak during their lock-up and decline by the time they could sell.
Acquisition
When another company buys your employer, vested units are converted into whatever the deal specifies: cash, acquirer stock, or a mix. The merger agreement sets the exchange ratio, and the distribution waterfall determines who gets paid first.
Many agreements include double-trigger acceleration for acquisitions. Under a double trigger, unvested units don’t automatically accelerate just because the company is sold. Two events must occur: the acquisition itself, and your involuntary termination (or resignation for good reason, like a pay cut or forced relocation) within a defined window afterward, often 9 to 18 months post-closing. Keep your job at the acquirer on comparable terms and your unvested units continue vesting on the original schedule. Check your grant for the specific trigger language before counting on acceleration.
Tender Offers and Repurchases
Outside of an IPO or acquisition, liquidity is scarce. Some companies sponsor periodic tender offers letting employees sell a portion of vested units back to the company or to approved secondary buyers, usually at the most recent 409A price. Others include mandatory repurchase provisions in the operating agreement. Neither option is universal, and both are at the company’s discretion regarding timing and pricing.
What Happens If You Leave
Termination provisions vary enormously, and the details matter more than most employees realize until they’re leaving.
Unvested units are forfeited in virtually every scenario, regardless of why you leave. The more consequential question is what happens to units you’ve already earned.
Many agreements distinguish between “good leavers” and “bad leavers.” A good leaver is typically someone laid off, leaving due to disability, or departing on amicable terms. Good leavers usually keep their vested units or have them repurchased at fair market value. A bad leaver, someone terminated for cause, in breach of contract, or resigning without proper notice, faces harsher treatment. Bad leaver provisions can require selling vested units back to the company at a nominal price or original cost basis, effectively wiping out earned value. Some agreements eliminate payouts entirely for bad leavers.
Even as a good leaver, your vested units remain illiquid. You’ll hold them until a future liquidity event, and the operating or grant agreement may give the company a right to repurchase at a price it determines. Read the termination provisions in your grant agreement before you need them, not during your exit negotiation when the leverage has already shifted.