102-8 Equity-Based Compensation Flashcards
Stock options
Give the employee (usually an executive) the right to purchase a fixed # of shares of employer stock at a predetermined price over a stated period
Nonqualified stock options (NQSOs)
Not tax qualified
Grant date: not taxable
Exercise date: compensation income to employee; deduction for employer
Stock sale date: short-term or long-term capital gains depending on holding period
Bargain element
The difference between market value of the stock at any particular time and the option’s exercise price
Taxed at the date of the option’s exercise as W-2 compensation income
Employer receives deduction for the amount of the bargain element when the employee brings that amount into income
Incentive Stock Options (ISO)
- must be part of written plan approved by stockholders
- exercise date can’t be > 10 yrs after grant date
- exercise price can’t be less than market price at grant date
- max value of stock that can be exercised in 1 yr: $100k
- shares can’t be sold within 2 yrs of grant date or 1 yr of exercise date
Grant date: not taxable
Exercise date: AMT adjustment item to employee; no deduction for employer
Long-term capital gains if meeting special holding period rules
Alternative minimum tax (AMT)
The employee must report the bargain element of the ISO as of the exercise date as an AMT adjustment item
Cashless exercise of NQSOs and ISOs
Suitable for employees who don’t have enough cash to satisfy the exercise price and any other costs associated with exercising the option
Employee sells enough stock to cover the amount they need to purchase + income tax (to cover bargain element)
Employee stock purchase plans (ESPPs)
Provide employees with options to purchase employer stock through payroll deductions
- nondiscriminatory
- often limit amount that employee can purchase
- if plan meets requirements, no income tax implications to employees at either grant or exercise date
The price is typically 85% of the lesser of the price at the beginning of the accumulation period or at the end of the accumulation period
Restricted stock
NOT a stock option
Employer stock that’s forfeited by employee/exec of employment performance is not satisfactory or if employment terminated before a requisite period
Stock value not subject to income tax as long as the stock is subject to a substantial risk of forfeiture
When stock is no longer subject to substantial risk of forfeiture, the value of the stock is taxed as W-2 compensation income
Facts and circumstances test for substantial risk of forfeiture:
- Employee doesn’t remain w/ employer for a specified period
- Employee doesn’t meet certain sales or performance goals
- Employee goes to work for a competitor
- Employee works for a corporation that isn’t controlled by immediate family members
Section 83(b) election
Employee who receives restricted stock may elect to recognize the W-2 compensation income immediately rather than wait until the substantial risk of forfeiture expires
Must be made within 30 days of receiving
Any subsequent appreciation in the value of the stock is treated as a capital gain and may be taxed at lower capital gain rates when the stock is sold
If the exec makes the election and then forfeits the stock, he is not allowed a deduction of refund of tax paid on previously reported income
Junior class shares (JCSs)
A separate class of common stock whose voting and dividend rights are subordinate to the regular class of common stock issued by a corporation
Typically convertible into regular shares upon certain specified events
Taxed more favorably than NQSOs
Not taxed when shares are converted
Taxation deferred until sale of the regular shares, employee pays capital gain
Phantom stock arrangements
Used by closely held corporations that wish to reward their highly valued employees, but don’t want additional shareholders
Each year, employee/exec becomes vested in the shares, and lump-sum payments normally are made at the executive’s retirement or some other specified event
Payment made in cash
Employee taxed at income tax rates
Employer receives tax deduction
Stock appreciation rights (SARs)
Similar to phantom stock plans except SARS give the employee/exec a choice of when to exercise the right to share in the appreciation of the closely held company’s stock
Used heavily by closely held businesses that are unable to offer traditional forms of ownership, such as LLCs and S corps, which are restricted from having more than 100 shareholders
Gifting an NQSO
Employee recognizes no gain on the transfer to a family member or charity
May potentially remove the option and shares of stock from the taxable assets of the estate
Employee will have W-2 compensation income when either the family member or qualified charity exercises the option
If donee is a qualified charity, employee will be permitted a charitable deduction on the transfer date
