The items below detail various types of U.S. stock options that can be made available to staff and management. An interested company will need to have a valuation performed annually to determine the value of the company’s stock in order to properly account for any of the options below.
Restricted Stock Units (RSUs)
- The employee has the right to purchase shares at fair market value or a discount, or they may receive the shares at no cost.
- The employee doesn’t take possession of the shares until specified restrictions lapse (i.e. vesting period, company or individual performance goals are met).
- RSUs are settled in shares, not cash.
- The Employee can make a Section 83 (b) election, which allows for them to be taxed at the ordinary income tax rates on the gain of the award at the time of grant.
- The employee decides not to make the 83 (b) election; they must pay ordinary income tax rates on the difference between the amount paid for the shares and the fair market value at time of lapse of restrictions.
Phantom Stock and Stock Appreciation Rights (SARs)
- 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 specific period of time.
- SARs – 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.
- Both are bonus plans that don’t grant stock, but instead the right to receive an award based on the value of the company’s stock.
Employee Stock Purchase Plans (ESPPs)
These are formal plans to allow employees to set aside money over a period of time, commonly out of taxable payroll deductions, to purchase stock at the end of the offering period.
Incentive Stock Options (ISOs)
Enable the employee to defer taxation on the option from the date of exercise until the date of sale of the underlying shares, and also pay taxes on their entire gain at capital gain rates, rather than ordinary income tax rates. Certain conditions must be met in order for the employee to qualify:
- The employee must hold the stock for at least one year after the exercise date and for two years after the grant date.
- Only $100,000 of stock options can first become exercisable in any calendar year.
- The exercise price must not be less than the market price of the company’s stock on the date of the grant.
- Only employees can quality for ISOs.
- The option must be granted pursuant to a written plan that has been approved by shareholders and that specifies how many shares can be issued under the plan as ISO and identifies the class of employees eligible to receive the options. The options must be granted within 10 years of the date of the board of directors’ adoption of the plan.
- The option must be exercised within 10 years of the date of grant.
- If, at the time of the grant, the employee owns more than 10% of the voting power of all outstanding stock, the company, the ISO exercise price must be at least 110% of the market value of the stock on that date and may not have a term of more than five years.
Non-qualified Stock Options (NSOs)
- If the employee exercises, they will be taxed on the difference between the exercise price and market value of the stock at the time of exercise as ordinary income, even if the sharers are not yet sold. A corresponding amount is deductible by the company.
- There is no legally required holding period for the shares after exercise, although the company may impose one.
- All subsequent gains/losses on the shares after exercise would be taxed at capital gain rates.
Employee Stock Ownership Plan (ESOP)
A qualified, defined contribution plan that invests primarily in employer stock.
- Shareholder has the ability to sell any percentage of the company, while maintaining operational control
- An S-corporation is exempt from federal taxes.
- The sponsor company makes contributions to the ESOP that are deducible pre-tax as an employee benefit expense (certain limitations may apply).
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