Under Section 83 of the Internal Revenue Code, the value of property transferred in connection with the performance of services is included in gross income, and is recognized as such on the date on which the property is no longer subject to a substantial risk of forfeiture, or the date on which the property becomes transferable, whichever is earlier. This provides more flexibility to the employee. Stock options have become the standard at private companies for two primary reasons: For these plans, if vesting has not occurred by the expiration date, the grant is forfeited.
She can now sell her stock for a monetary gain. But there is a wrinkle. This diagram shows the payout to Mary at different values of common stock. If the intrinsic value of an option is greater than zero, it is in-the-money. This happens when its strike price is less than the per-share value of common. If the intrinsic value of an option is zero, it is called out-of-the-money.
This happens when its strike price is greater than or equal to the per-share value of common. ISOs have some great tax benefits! Typically the US government taxes vesting securities, such as restricted stock, as they vest. This can create problems for employees—especially at startups.
Employees may not have the cash available to pay the taxes. The holder of an option whether it be an NSO or ISO does not pay any tax as the option vests, and an optionee that never exercises their options will never pay tax. NSOs get taxed on the date of exercise. ISOs are even better; with an ISO, there is no tax obligation until the underlying security stock is sold.
You should seek the guidance of a qualified tax professional whenever exercising options. What will her tax be? Because Mary exercised her shares more than 12 months ago, she qualifies for the long-term capital gains rate. This is a great benefit of ISOs — they can help employees reduce their tax obligation. Most employees wait until the company is sold to exercise their options a same-day sale. In one day, they both exercise their options for shares and sell those shares to the purchaser of the company.
This disqualifies them from receiving long-term capital gains tax treatment. They are instead taxed at the short-term capital gains rate, which is equivalent to their ordinary income tax rate. What would happen if Mary did not exercise until the company sells? Upon sale of the stock, Mary would pay taxes at the ordinary income tax rate. These tax saving can be realized by all employees, even if their options have not vested, as long as they have the choice to early exercise their options.
There are some risks though. Read our discussion of early exercise here. In conclusion, the upside potential and tax treatment of options, especially ISOs, have made them popular with high-growth private companies. Stock options have worked great for private companies for years.
But there are some drawbacks. For one thing, their biggest strength is also their weakness. After all, the point is to incent them to help the company grow. These scenarios can lead to employees with out-of-the-money options. Most of the time, these scenarios require re-issuing options to employees to keep them motivated. Re-issuing stock options is painful and costly. Stock options turn your employees into official shareholders once they exercise. And they have a legal right to exercise their shares as soon as their shares vest.
So granting options will almost guarantee the increase of your shareholder base, and shareholders come with a bunch of baggage.
For example, in the U. Many successful companies exceed this threshold before they IPO. This is one reason why Facebook stopped issuing options. Shareholders also have voting and information rights. You may not want to have to disclose sensitive company information to a disgruntled employee who exercises options on their way out the door.
For private companies, granting stock options will also require a A valuation. Restricted Stock Units seem like a natural fit because they are quite similar to options.
RSUs are often subject to vesting. Employees with vested RSUs have to wait for the vesting to get cash or stock. It is common to vest RSUs over time just like options. You can also vest RSUs using milestone triggers like achieving a certain amount of revenue or even the sale of the company. RSUs do not have a strike price. This means that they will have some value as long as common stock has value.
This can be a huge benefit for employees. Because RSUs do not have a strike price, they have better downside protection relative to options. Securities with downside protection have features that protect or enhance their value even when a company is performing more poorly than expected.
When you grant RSUs, you typically do not need to establish their fair market value. This means you do not need to pay for a A valuation. Many private companies still want to know their common stock value for other reasons like ASC , but it is not a requirement for granting RSUs. RSU recipients do not become shareholders until they receive stock. Executive compensation practices came under increased congressional scrutiny in the United States when abuses at corporations such as Enron became public.
Prior to , stock options were a popular form of employee compensation because it was possible to record the cost of compensation as zero so long as the exercise price was equal to the fair market value of the stock at the time of granting.
Under the same accounting standards, awards of restricted stock would result in recognizing compensation cost equal to the fair market value of the restricted stock. However, changes to generally accepted accounting principles GAAP which became effective in led to restricted stock becoming a more popular form of compensation. Under Section 83 of the Internal Revenue Code, the value of property transferred in connection with the performance of services is included in gross income, and is recognized as such on the date on which the property is no longer subject to a substantial risk of forfeiture, or the date on which the property becomes transferable, whichever is earlier.
In the case of restricted stock, the former date is generally known as the "vesting date" and is the date when the employee recognizes income for tax purposes assuming that the restricted stock is not transferable at an earlier date, which is how employers generally structure their restricted stock awards.
Employees pay income tax on the value of the restricted stock in the year in which it vests, and then pay capital gains tax on any subsequent appreciation or depreciation in the value of the restricted stock in the year in which it is sold. A grantee of restricted stock may make an "83 b election" to recognize the income from the restricted stock grant based on the fair market value of the restricted stock at the time of the grant, rather than at the time of vesting.
Revenue authorities in the United Kingdom and the Republic of Ireland have issued guidelines on the taxation of restricted stock and RSU awards. Restricted stock is generally incorporated into the equity valuation of a company by counting the restricted stock awards as shares that are issued and outstanding.
This approach does not reflect the fact that restricted stock has a lower value than unrestricted stock due to the vesting conditions attached to it, and therefore the market capitalization of a company with restricted stock outstanding may be overstated.
However, restricted stock has less of an impact than stock options in this regard, as the number of shares awarded tends to be lower and the discount for illiquidity tends to be smaller. The calculation may be based on prior business day's close, average high and low for the day, real-time price, or today's close.
Fair market value per share is the fair market value for federal income tax purposes divided by the number of RSUs you own. The expiration date is the date on which your RSU agreement expires. For restricted stock that vests based on time, the expiration date is immaterial. If vesting is based on factors other than the simple passage of time, such as performance measures, the expiration date is the end of the period within which vesting is possible.
For these plans, if vesting has not occurred by the expiration date, the grant is forfeited. Please refer to your company's plan rules to understand whether any expiration dates will apply under your plan. For accepted grants, select View Details. You can also view your plan document and grant agreement when you accept or decline an unaccepted grant.
The plan document and grant agreement are in PDF format. You can view a history of all transactions for your restricted stock units plan for the past 10, 30, 60, 90, or days. Transactions appear in reverse chronological order, but you can also sort the list of transactions by transaction type, grant ID, grant date, or quantity.
You can view details pertaining to accepted and declined grants. On the Unvested Grants page, you can view the vesting date, grant date, grant ID, number of units, and tax withholding method for each unvested grant. You can also view a grant's estimated value upon vesting, and an estimate of the taxes you may owe upon vesting. The View Details page for an unvested grant also shows you the estimated fair market value per share , total estimated taxable income, and tax withholding amounts and percentages broken out by Federal, State, and Medicare.
See Accepting and Declining Grants for details. Under normal federal income tax rules, an employee receiving restricted stock units is not taxed at the time of the grant. Instead, the employee is taxed at vesting, when the restrictions lapse, unless the plan allows for the employee to defer receipt of the cash or shares. In these circumstances, the employer has certain withholding obligations which may or may njot cover the entire tax liabiliity for the employee at vesting or distribution.
Payment of all other taxes can be deferred until the time of distribution, when the employee actually takes receipt of the shares or cash equivalent depending on the company's plan rules.
The amount of income subject to tax is the difference between the fair market value of the grant at the time of vesting, minus the amount paid for the grant, if any. For grants that pay in actual shares, the employee's tax holding period begins at the time of distribution which may or may not coincide with vesting depending on the plan rules , and the employee's tax basis is equal to the amount paid for the stock plus the amount included as ordinary compensation income.