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Breaking Down Stock Compensation Plans

By May 25, 2016No Comments

Companies often use stock-based compensation plans to attract and retain the best talent. When structured properly, these plans provide advantages from a tax perspective. Click below to learn about the different types of plans that exist and the tax advantages of each. Please contact our office if you have questions about your stock compensation plan. There may be tax planning opportunities you are missing out on!

Unrestricted Stock Grants –


Shares of the company’s stock are transferred outright to the employee in an unrestricted stock grant, usually at a discounted rate or at no cost at all.

Tax Treatment –

At the time of grant (or receipt, which occurs concurrently), the employee will pay ordinary income tax on the excess of the fair market value (FMV) of the stock over the amount paid. A problem may exist if the employee does not have the cash to pay the tax. When this fact pattern exists, the company has the option to withhold a portion of the shares to cover the taxes. When the employee sells the stock, capital gain will be recognized on the difference between the sale price and the FMV at the time of grant.

Restricted Stock Grants –

Description –

Restricted stock grants provide great incentives for employees to thrive within the company and are, therefore, utilized frequently by progessive companies such as Apple and Facebook. Unlike unrestricted stock grants, these grants need to vest, which requires the employees to earn rights to the stock over a specified period of years or upon the attainment of certain performance goals. Two types of restricted stock grants exist: RSA’s (restricted stock awards) and RSU’s (restricted stock units). When you receive an RSA, your company offers you shares at the time of the grant, although you cannot access those shares until vesting. When you receive an RSU, the company promises to give you a certain number of shares at a future date, but you do not own those shares until vesting.

Tax Treatment –

Generally, tax treatment is the same in restricted stock grants as it is in unrestricted stock grants. The only difference is that the ordinary gain portion is recognized on the date of vest versus the date of grant.

Incentive Stock Options (ISOs) –

Description –

ISOs are very popular because of the beneficial tax treatment it provides to recipient employees. However, many requirements need to be met in order for a stock to qualify as an ISO. The most notable requirements are that: the employee must hold the stock for at least one year after the exercise date and for two years after grant date; the option must be exercised within 10 years of the date of grant; and the employee must exercise the option during their employment period or within three months after termination.

Tax Treatment – 

Unlike most other stock compensation plans, tax consequences generally do not occur on the grant or exercise date. Instead, income tax is not paid until the stock is sold and the sale receives long-term capital gain treatment. However, the gain is subject to alternative minimum tax on the date of exercise and may result in additional tax depending on the employee’s tax situation.

Non-Qualified Stock Options (NQSOs) –

Description –

NQSOs do not have the stringent criteria associated with ISOs. The advantage of these types of options are the flexibility permitted to both the employer and employee. An employee is permitted to acquire a specific number of shares at a future date at a set price.

Tax Treatment –

Ordinary income is recognized on the FMV of the stock on the date of exercise less the exercise/strike price. Since there is more flexibility over the date of exercise, it is generally delayed until the employee is ready to sell some stock (same-day sale), which frees up cash for to pay the tax on the gain. In a same-day sale, the employee generally recognizes a small short-term capital loss in the amount of the commission paid in the transaction. If the stock is sold at a later date, capital gain treatment is recognized in the amount of the difference between the sale price and the FMV at the date of exercise.

Employee Stock Purchase Plans (ESPPs) –       

Description –

Sometimes companies offer its employees the ability to purchase stock through an employee stock ownership program. In this scenario, money is automatically taken out of the employee’s paycheck on an after-tax basis to purchase company stock. The stock price to the employee is generally discounted.

Tax Treatment –

The sale is considered qualifying if the stock was held for at least one year from purchase date and the two years from offering date. If these conditions are met, then the discount received by the employee is reported as ordinary income and any excess gain between the sales and purchase price is reported as long-term capital gain.

Stock Appreciation Rights (SARs) and Phantom Stock –

Description –

Stock Appreciation Rights and Phantom Stock are both ways an employer can reward employees without giving up equity in the company. They are bonus plans that grant the employee the right to receive a reward based on the value of the company’s stock. SARs typically provide the employee with a cash or stock payment based on the increase in the value of a stated number of shares over a specific period of time. Employees may have the flexibility to choose when to exercise the option. Phantom stock provides a cash or stock bonus based on the value of a stated number of shares, to be paid out at the end of a specified period of time.

Tax Treatment –

 When the payout is made, the value of the award is taxed at ordinary income rates to the employee.

Strategies for Paying Taxes –

Several strategies are available for those who do not have the cash to pay the income taxes associated with stock compensation. The phenomena is not uncommon since tax is oftentimes triggered before the sale of the stock and, thus, before the cash is received. One method is to sell enough shares to cover the taxes. The other way is to withhold a portion of the shares to fulfill the tax obligation. The least attractive option is to use external financing by opening a line of credit.

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