Equity Compensation Advisor

As a follow up from last week’s blog, Overview of Employee Stock Purchase Plans (ESPPs), I would like to discuss the taxation of ESPPs.

Under most ESPPs, an employee that participates in the plan makes their purchases of company stock through payroll deductions.  All of the purchases are made with after tax dollars.  As mentioned last week, if the plan is a qualified 423 Plan ESPP, the employee can receive special tax treatment on the purchased shares.

Because the shares are purchased with pre-tax, at the time of purchase, the employee does not report any income.  The tax occurs once the shares are sold.  The challenge is determining whether the shares sold are considered a qualifying sale.  A qualifying sale occurs when a disqualifying disposition is avoided.

How does an employee avoid a disqualifying disposition?  Simply put, the employee must meet two (2) requirements.
1.   No disposition occurs within two years from the grant date, i.e., the beginning of the offering period.
2.   No disposition occurs within one year after the shares are transferred to the employee.

If the employee meets this criteria, they can avoid a qualifying sale when the amount of income they would report would be the lesser of the following two amounts:
•    The difference between the fair market value of the shares on the date of disposition and the amount paid to acquire the shares.
•    The bargain element at the beginning of the offering period.

What is the Bargain Element?  The bargain element is the difference between the fair market value of the stock at the beginning of the offering period and the price that would have been paid for the stock if it were purchased at the beginning of the offering period, versus over a period of time.  This usually is the 15% discount the company offers.

Dan’s Moral: Understanding the holding period needed to avoid a disqualifying disposition could save a lot in taxes.

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For more information on Dan Langworthy and Executive Capital, LLC you can also visit our website: http://www.executivecapitalmn.com and view Dan’s profile on Linkedin http://www.linkedin.com/in/danlangworthy

Securities and advisory services offered through LPL Financial, a Registered Investment Advisory, Member FINRA/SIPC

Restricted Stock Units; Part 2 of my five-part blog series on the tax implications of the five types of equity compensation:    Restricted Stock Grants, Restricted Stock Units, Stock Appreciation Rights, Non-qualified Stock Option, Incentive Stock Options

 Throughout this series, we will discuss the tax implications of each of the five types of equity compensation first as described in my previous blog published 11/29/2011 (“Five Types of Equity Awards”). 

In my previous blog, Part One of the series, we discussed Restricted Stock Grants, and the tax implications involved.  Part Two consists of defining the second type of equity compensation; Restricted Stock Units (RSU’s), and important components including forfeiture, tax consequences, timing and more.

• Restricted Stock Units (RSU’s) are very similar to Restricted Stock Grants with one exception, the time when the shares are transferred.  Restricted Stock Grants are transferred at the time of the grant even though the executive may not have direct access to the shares due to possible forfeiture based on the vesting schedule.
• In the case of RSU’s the company does not transfer shares at the time of the grant.  The shares are transferred once the employee has worked long enough to meet the required time period.  Fundamentally, the employee would not be entitled to any dividends until the shares are transferred.  Also, due to the fact that the shares are not transferred at the time of grant, the executive cannot file a section 83b election to convert future appreciation of the shares to capital gain. 

Keeping in mind that since the executive does not have access to the shares when granted, there are no tax consequences until the shares are transferred.    At the time of transfer, the shares become vested and the executive will report compensation income on the entire value of the shares.  This amount is the cost basis for tax purposes.

Dan’s Moral:  Because the company determines the timing and restrictions placed on RSU’s, the only decision the executive needs to make is whether to hold the shares at the time of transfer or sell them.

• Please be sure to subscribe to our blog to be automatically notified as the series continues on the “Tax Implications of the Five Types of Equity Compensation, Part 3″. 

For more information on Dan Langworthy and Executive Capital, LLC you can also visit our website: http://www.executivecapitalmn.com and join Dan’s network on Linkedin http://www.linkedin.com/in/danlangworthy

Securities and advisory services offered through LPL Financial, a Registered Investment Advisory, Member FINRA/SIPC

Knowing the different types of equity awards that corporations issue and what the executive owns is important.
• Restricted Stock Grants
These awards of company stock are referred to as restricted because the executive is restricted from selling the shares for a period of time. Usually this is through a vesting schedule so that employee will forfeit some or all of the shares if they terminate before the shares are vested.
• Restricted Stock Units (RSU’s)
The main difference between restricted stock units and restricted stock grants is the date when the company transfers the shares. Restricted Stock Grants are transferred at the time of the grant. Restricted Stock Units transfer the shares at the time of the vesting date. Therefore, the holder of the RSU’s will not benefit from any dividends that have been paid prior to the date of transfer.
• Stock Appreciation Rights (SAR’s)
SAR’s allow the executive to receive cash in the amount equal to the increase in value based on the original stock price and the number of shares that were issued.
SAR’s are similar to options because the holder determines when to exercise the rights subject to the vesting schedule. Exercising the SAR provides the holder with immediate cash unless the company granted the SAR’s to pay off in stock.
• Non-qualified Stock Option (NQO)
NQO’s permit the option holder to purchase a specific number of shares of company stock at a specific price the day the company granted the options. The option holder must pay the exercise price (grant price) at the time of exercise. The difference between the exercise price and current price is the gain (bargain element). NQO’s are options that do not qualify for special tax treatment.
• Incentive Stock Options (ISO’s)
The main difference between NQO’s and ISO’s is ISO’s do qualify for special tax treatment, allowing the option holder to convert some or all of the income into capital gains. The rules and strategies to take advantage of the special tax treatment can be complicated. The main reason a company would issue ISO’s is to provide a tax benefit to the option holder.
I will discuss the tax consequences of each of these equity awards in the following 5 part series.

Securities and advisory services offered through LPL Financial, a Registered Investment Advisory, Member FINRA/SIPC