Press Room

22 Sep 2019

Equity Compensation


Dennis Minnich considers the different types of equity compensation?

Restricted Stock & Restricted Stock Unit

Grantees are granted the right to receive shares of company stock, subject to vesting terms. A granted restricted stock receives the stock subject to vesting on the date of grant, while a grantee granted a restricted stock unit receives the stock after the vesting period.

Conditions:

  • Can be granted to employees, consultants, board members and other service providers.
  • Vesting restriction lapses if the grantee continues to provide services to the company for a certain number of years, often four to five.
  • Vesting can be based on the passage of time or performance metrics.

Tax Implications:

Restricted Stock

  • Grantee recognizes compensation income on the vesting date equal to the difference between the fair market value of the stock on such date and the amount, if any, paid for the stock.  Subsequent changes in the value of the stock treated as capital gain or loss when the stock is sold.
  • Grantee has the right to make a “Sec.83(b)” election to recognize compensation income at the time the restricted stock is granted equal to the difference between the fair market value of the stock on the date of grant and the amount, if any, paid for the stock. Any future change in the value of the shares between the grant date and the sale date is then taxed as capital gain or loss.
  • If the grantee is an employee, the company is required to withhold the appropriate federal and state income taxes, as well as social security taxes and Medicare taxes.

Restricted Stock Unit

  • Grantee recognizes compensation income when the stock is transferred to the grantee after satisfying the vesting requirements.
  • The amount of compensation recognized is equal to the difference between the fair market value of the stock on the date of transfer and the amount, if any, paid for the stock.
  • The company entitled to an income tax deduction for the amount included in the employee’s income.
  • If the grantee is an employee or former employee, the company is required to withhold the appropriate federal and state income taxes, as well as social security taxes and Medicare taxes.

Incentive Stock Options

An employee is granted the right to purchase a certain number of shares of stock at an established price with the advantage that no income is reported when the option is exercised and, if certain requirements are met, the entire gain when the stock is sold is treated as long-term capital gains.

Conditions:

  • Can only grant incentive stock options to employees.
  • Stock must be held for at least one year after the exercise date and for more than two years after the grant date.
  • May only be granted $100,000 of stock options (based on the fair market value of the stock on the date of grant) that becomes exercisable for the first time in any calendar year.
  • Exercise price must not be less than the market price of the company’s stock on the date of the grant.
  • Must be granted under a board-approved written plan document that has been approved by stockholders within 12 months of plan adoption.
  • Must be exercised within 10 years of the date of grant and within three months of termination of employment.
  • Employee cannot, at the time of grant, own stock representing more than 10% of voting power of all stock outstanding, unless the option exercise price is at least 110% of the fair market value and the option expires no later than five years from the time of the grant.
  • Incentive stock options generally subject to a vesting schedule of four to five years.

Tax Implications:

  • Upon exercise of an incentive stock option, the employee recognizes income only for alternative minimum tax purposes equal to the difference between the fair market value of the stock on the date of exercise and the exercise price.
  • If the employee holds the stock for the one-year and two-year holding periods after exercise, then the difference between the sale price of the stock and the exercise price will be treated as long-term capital gains for regular income tax purposes.
  • If the employee does not hold the stock for the one-year and two-year holding periods after exercise, then the lesser of (i) the difference between the fair market value of the stock on the date of exercise and the exercise price, and (ii) the difference between the fair market value of the stock on the date the stock is disposed and the exercise price will be treated as compensation income.
  • The employer is entitled to an income tax deduction for the amount that is treated as compensation income to the employee.
  • The amount reported as compensation income to the employee is not subject to federal and state income tax withholdings nor is it subject social security tax and Medicare tax withholdings

Non-Qualified Stock Options

Optionee is granted the right to purchase a certain amount of the company’s stock for a fixed price after a defined period of time resulting in additional compensation income to the optionee at the time of exercised.

Conditions:

  • Nonqualified stock options may be granted to employees, consultants, board members and other service providers.
  • No limit on the number of options that may be granted to a person.
  • Exercise price generally equal to or greater than the fair market value of the stock on the date of grant.  May issue nonqualified stock options with a discounted exercise price, however, the terms of the option must restrict the timing of exercise.
  • Options general subject to a vesting schedule of four to five years.  Vesting can be based on passage to time or performance metrics.

Tax Implications:

  • No income tax consequences on date of grant.
  • At the time of exercise, optionee recognizes compensation income on the difference between the fair market value of the stock on the date of exercise and the exercise price. Subsequent change in the fair market value of the stock treated as a capital gain or loss when the optionee sells the shares.
  • Employer is allowed an income tax deduction equal to the amount the option recognizes as compensation income.
  • If the optionee is an employee or former employer, the company is required to withhold the appropriate amount of federal and state income taxes as well as social security taxes and Medicare taxes.

Julian Nelberg

Julian is Head of the Private Client group at Andersen LLP. His clients include international high net worth individuals, senior executives, trusts and companies.

Email: Julian Nelberg