Equity Compensation and Corporate Taxes

Many businesses are finding it more challenging to attract quality, talented employees in today’s market. This is particularly true for start-ups, which generally lack the capital to attract prospective workers with competitive pay and benefits. Equity compensation is one method often used to this end. However, one needs to plan carefully, for the company may experience tax advantages, but also liabilities. A Boston tax attorney can assist business owners in determining if equity compensation is appropriate for their enterprise.

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Equity Compensation Explained

Equity compensation entails the offering of some form of non-cash compensation to prospective employees, generally in the form of stock options or restricted stock. A number of ways to offer these stocks exist for companies, and tax issues related to equity compensation can be quite complex, for which a Boston tax attorney is best-suited to explaining how each kind of compensation can affect both the employer and employees.

Stock Options

A stock option offers prospective and current employees a right to purchase corporate stock over a period of time. The price is determined at the time of offer, and rights accrue toward the employee. Employees who are provided with stock options do not have voting rights, since they are not fully-vested.

There Are Two Main Kinds of Stock Options:

  • Incentive Stock Options (ISOs): ISOs allow employees to delay tax liability on the shares they own until they sell them. The corporation does not enjoy a tax deduction upon the sale of the stock.
  • Non-Qualified Stock Options (NQSOs): Employees who receive NQSOs must pay federal income tax in the year they exercise their purchase option. Employers, on the other hand, receive a tax deduction at this time. It should be self-evident from this that NQSOs are generally the form of stock option corporations prefer to offer employees who are not executives.

Restricted Stock

Employees who receive restricted stock have voting rights at stockholder meetings, as well as all other rights under the law. The employer retains certain repurchase rights that diminish over time. If an employee is terminated for good cause or leaves the company before such time these repurchase rights expire, the company may exercise its rights.

When the employer exercises its repurchase right, the company is subject to paying income tax on the difference between the original purchase price of the stock and the fair market value at the time the repurchase phase ends. These taxes are due over that period, unless the corporation elects to pay them all at once via the Internal Revenue Code Section 83(b).

For Further Information

If you are considering offering equity compensation to employees, and need assistance or further information, call a Boston tax attorney at Ionson Law: (781) 674-2562.

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