Understanding Stock Appreciation Rights
Stock Appreciation Rights (SARs) provide the holder with the right to receive cash compensation in an amount equal to the increase in value of a specified number of shares of stock.
Although you may be thinking SARs sound like stock options, the difference is that SARs do not require the holder to come up with cash at the time of exercise.
For instance, your client receives a SAR for 5,000 shares when the stock is trading at $30/share. Five years later when this client exercises their SAR, the stock is trading at $50/share, your client receives $100,000 (5,000 shares times the $20 increase per share).
Sometimes a company may pay a SAR in shares of stock instead of cash. In this example, the client receives 2,000 shares of stock in lieu of $100,000.
SARs are taxed the same as nonqualified stock options. The holder does not report income at the time they receive the SAR or when it becomes exercisable. They report compensation income on the amount of cash received. If the holder is an employee, the income is subject to withholding and social security tax. In the case of SARs that pay off in shares of stock, the holder reports compensation income equal to the value of the shares on the date the shares were transferred.
I understand that most companies granting SARS provide that they are payable only in stock. That is because the accounting treatment is unfavorable for SARs that must be paid out in cash. In the latter case, the company must use liability accounting, meaning that the awards have to be “marked to market” every quarter. This can result in large amounts of compensation expense in a quarter where the stock price increases significantly.
Comment by Martin Rosenbaum — July 19, 2010 @ 6:45 pm