Now is an especially tough time to find and retain quality employees. The competition for the best talent is fierce. Many employers are offering signing bonuses, higher salaries, better health insurance programs, richer retirement plans and other fringe benefits to attract employees. Another benefit employers should consider offering to their upper-level employees are restricted stock, stock options or stock appreciation right awards.
- Restricted Stock Awards: A restricted stock award gives an employee the right to receive or acquire shares of employer stock after certain specified requirements are met. The requirements could be working for a certain number of years or meeting specified performance goals. Upon exercise, the employee becomes a shareholder of the employer.
- Stock Appreciation Rights (SARs):SARs provide an employee the right to receive the increase in the value of a designated number of shares of employer stock. This increase is paid in cash upon the occurrence of a specified trigger event. The trigger event could be working for a certain number of years, retirement or termination of employment. An SAR gives the employee a right to receive compensation in the future, but does not give the employee any rights as a shareholder of the employer.
- Incentive Stock Options (ISOs): ISOs give the employee the right to purchase a specified number of shares of employer stock at fair market value on the date of exercise. ISOs are generally given only to a select group of highly-compensated employees or management. Upon exercise of the ISO, the employee is a shareholder of the employer.
- Non-Qualified Stock Options (NGSOs): NGSOs give the employee the right to purchase a specified number of shares of employer stock at a specified exercise price that might be more or less than fair market value on the grant date or exercise date. NQSOs can be given to any employees or directors or contractors. Upon exercise of the NQSO, the employee is a shareholder of the employer.
Restricted stock awards are taxable to employees for income and payroll tax purposes at the time the shares are vested and no longer subject to substantial risk of forfeiture. At the same time, the employer is able to take a compensation deduction in an amount equal to the compensation income recognized by the employee. The amount of the compensation income recognized by the employee and the deduction taken by the employer is equal to the excess of the fair market value of the stock on the date of exercise over the exercise price if any paid by the employee.
SARs are taxable to employees (cash basis taxpayers) for income tax purposes at the time the SARs are paid to the employee. Notwithstanding the foregoing, SARs are subject to payroll tax employer at the time the SARs are no longer subject to substantial risk of forfeiture. The amount of the compensation income and deduction resulting from payment of the SARS is equal to the amount of the SAR payment.
ISOs receive preferential tax treatment. The grant of an ISO is not subject to tax. The exercise of the ISO is also not subject to tax. The shares acquired upon exercise of the ISO are only subject to tax when sold, and are subject to tax as long-term capital gains. The amount of capital gains recognized by the employee when the shares are sold is equal to the sales price the employee receives for the shares less the amount the employee paid for the shares.
NQSOs are not subject to tax at time of grant, but are subject to tax at time of exercise. The employee recognizes compensation income for income and payroll tax purposes equal to the excess of the fair market value of the stock over the exercise price paid. The employer receives a compensation deduction in an equal amount.
When considering offering restricted stock or stock options to attract or retain employees, the employer needs to understand that the employees will become shareholders and enjoy all of the rights as shareholders which could include attending shareholder meetings, voting, receiving annual reports and other rights.
If you would like to learn more about SARs, stock options or other employee compensation plans, please contact one of our business or tax attorneys at 937-223-1130 or jsenney@pselaw.com.
