Stock-based compensation is a staple of senior executives and key management employees in privately held companies. In public companies, it is typically broad based as well. In both publicly traded and privately held companies, employees are almost uniformly interested in a piece of the pie and a stake in their future. Shareholders and directors, on the other hand, seem to be more interested than ever in tying executive and employee compensation to the performance of the company.
Whether a stock-based compensation strategy makes sense for your company or your client’s company will depend on a number of factors. This chart is excerpted from Kevin Long’s article Equity Sharing In Compensation Planning, which surveys the factors that may help you make that decision.
| From the article Equity Sharing In Compensation Planning | Non-Qualified Stock Options | Incentive Stock Options | Restricted Stock Plan | Phantom Stock Plan |
|---|---|---|---|---|
|
Description | Employees are granted options to purchase common stock, exercisable at some time in the future. Option price may be discounted. | Employees are granted options to purchase common stock, exercisable at some time in the future. | Company stock is granted to employee, subject to forfeiture, unless vesting conditions are satisfied. | A plan that grants units of phantom stock, which are valued based on the company’s common stock. |
|
Type Of Interest | Conveys right to purchase ownership interest in company. | Conveys right to purchase ownership interest in company. | Conveys ownership interest in company. | Conveys percentage of value of the company.No incidences of ownership.May include stock conversion feature. |
|
Limit On Grant Amount | No | Yes. No employee may accrue more than $100,000 worth of options per year (valued at date of grant). | No | No |
|
Minimum Purchase Price |
No | Yes. Not less than the fair market value of the stock at the date the option is granted. |
No |
N/A |
| Distributions Payable In | Stock | Stock | Stock | Cash or stock |
| Who Is Eligible To Participate? | All or some employees. | All or some employees. | All or some employees. | All or some employees. |
| Out Of Pocket Cost To Employee? | Employee must pay for shares purchased at the stated exercise price. | Employee must pay for shares purchased at the stated exercise price. | No | No |
|
When Is Employee Taxed? |
NSOs are taxed on the “spread” at the time of exercise and on final disposition. |
ISOs are not taxed on exercise; but are taxed at the time of sale of shares (if holding periods met). | At time stock vests (i.e., when it is no longer forfeitable), or when it becomes transferable. But if employee makes an IRC 83(b) election, the time of taxation is accelerated to the year of grant. |
At time of payment. |
|
What Amount Is Taxable Income To Employee? |
The difference (“spread”) between the fair market value of the stock at the date of exercise and the exercise price. |
The difference between the sale price of the stock when sold and the exercise price paid by employee to acquire the stock. |
The fair market value of the stock at the time it becomes vested or restrictions on transfer lapse. | If cash, the value of the cash benefit paid to employee. If stock, the difference between the fair market value of the stock at the time it becomes vested or restrictions on transfer lapse and the amount paid for the stock by employee. |
| Tax Treatment | Ordinary income on the spread on exercise. Capital gain on appreciation at disposition. |
Capital gain on appreciation at disposition. | Treated as ordinary income to employee. But if employee makes an IRC 83(b) election, ordinary income on the FMV of the stock over amount paid. Capital gain on appreciation at sale by employee. |
Treated as ordinary income to employee. |
| Holding Period For Favorable Tax Treatment |
None | 2 years from grant date and one year from exercise. |
N/A |
N/A |
|
Vesting | May condition right to exercise on acquisition, completion of stated number of years of service, on stock value reaching certain level or other performance goals (5 years for state law). | May condition right to exercise on acquisition, completion of stated number of years of service, on stock value reaching certain level or other performance goals (5 years for state law). | May condition right to exercise on acquisition, completion of stated number of years of service, on stock value reaching certain level or other performance goals. | May condition right to exercise on acquisition, completion of stated number of years of service, on stock value reaching certain level or other performance goals. |
| Payment Triggers |
N/A |
N/A |
N/A | Prior to or at termination/retirement. Death Acquisition |
| Maximum Period For Exercise | No maximum period. | 10 years maximum exercise period. | N/A | N/A |
| Can Employee Exercise Before Date Of Acquisition/ Merger? | Permissible to limit options so that employee may only exercise in the event of acquisition/ merger. | Permissible to limit options so that employee may only exercise in the event of acquisition/merger (subject to maximum ten year exercise period). |
N/A |
N/A |
|
Accounting Considerations | Charge to earnings if price is below fair market value. Will decrease earnings per share due to dilution. | No charge to earnings since price equals fair market value. Will decrease earnings per share due to dilution. | May require employer to recognize compensation expense equal to the fair market value of the stock at the date of grant, less any amount paid by the employee, amortized over the vesting period. |
Company must recognize a compensation expense as employee’s interest in the award increases. |
|
Is The Stock Or Stock Option Transferable By The Employee? | Option may not be transferable; stock is generally transferable after exercise, but can be subject to restrictions on transfer. |
Options may not be transferable; stock must be held for required period to avoid taxable event for employee. |
Stock is subject to forfeiture and restrictions on transfer. |
N/A |
|
When Can The Company Take Deduction? |
Delayed deduction. Can deduct amount of income recognized by employee at the time the employee recognizes income (i.e., year of exercise). |
No deduction. | Delayed deduction. Can deduct amount of income recognized by employee at the time the employee recognizes income (i.e., year stock vests or restriction on transfer lapse) But if employee makes an IRC 83(b) election, the time of deduction is accelerated (i.e., year of grant). |
Delayed deduction. Can deduct amount of income recognized by employee at the time employee recognizes income (i.e., year payment is made). |
