Equity-based Compensation Taxation

Equity Based Compensation Tax Implication

Equity based compensation allows the employees of the firm to share in the profits via appreciation of the stock value and the company can encourage employee retention, particularly if there are vesting requirements. The planning is a key to tax savings for the exercise or sale of the stocks. Please contact us if you have any questions. 

There are several types of the equity based compensation.

Employee Stock Options (NQSO or ISO) – stock options give the employee the right to purchase a fixed number of shares of employer stock at a fixed price over a stated period. The grant of the stock option is generally a nontaxable event because the option price is usually made equal to the stock’s market price on the grant date. However, taxes (either regular or AMT) rise when the stock option is vested or exercised (depending on the type – Nonqualified Stock Option NQSO or Incentive Stock Option ISO).

Transferring stock options to family members or other persons can trigger taxation if not properly planned.

Employee Stock Purchase Plans (ESPPs) – ESPPs are options that give the employees the right to purchase employer stock (normally at a discount). To receive favorable tax treatment, the acquired shares must be held by the employee for at least two years from the grant of the option and one year after the exercise.

Phantom Stock (Shadow Stock) – a fictional, deferred compensation units account created as an accounting entry. The assigned base value of the units is equal to the current value of the company’s common stock. The plan may provide for adjustments to the account for appreciation of the common stock. Upon retirement or some other termination event, the participant receives the vested value of the account either as a lump sum or in installments. The payment will be in the form of cash.

Stock Appreciation Right (SARs) – Similar to Phantom stocks, except it gives the right to the monetary equivalent of the increase in the value of shares of stock over a specified period.

Restricted Stock – is employer stock that is forfeited if the executive’s performance is subpar or if the executive terminates employment before a stated period. The value of the stock will not be subject to income tax as long as the stock is subject to a substantial risk of forfeiture. When the stock is no longer subject to a substantial risk of forfeiture, the value of the stock (less any amounts paid for the stock by the employee) will be taxed as W2 income to the employee. There is Section 83(b)election that can potentially lower the overall tax. Please consult us if you have any questions in this regard.