How restricted stock and restricted stock units (RSUs) are taxed

How do stock options affect the employee? No specific changes in currently required disclosures of repricings in proxy statements are expected in the near future. In any case, he adds, the overall issue of stock options could shift if the Financial Accounting Standards Board FASB adopts a rule currently under consideration that would require companies to recognize the value of compensation-based stock options as an expense on the income statement. Hoping to hold on to its employees, Google is extending the vesting period for each swapped option by a full year. Only employees of the employer sponsoring the ESPP and employees of parent or subsidiary companies may participate. Qualified plans allow employees to take capital gains treatment on any gains from stock acquired under the plan if rules similar to those for ISOs are met, most importantly that shares be held for one year after the exercise of the option to buy stock and two years after the first day of the offering period. The difference must be reported by the shareholder as ordinary income.

In contrast, when an option is repriced the fixed nature of the stock option arguably no longer exists because in the course of the option’s life the exercise price has been changed. This causes the option to be treated under so-called “variable” accounting rules.

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Includes a comprehensive chapter on ESPPs. A quick reference guide to equity compensation in the form of four double-sided laminated sheets. Read our membership brochure PDF and pass it on to anyone interested in employee ownership. A nonprofit membership organization providing unbiased information and research on broad-based employee stock plans. Renew an Existing Membership. Each kind of plan provides employees with some special consideration in price or terms. We do not cover here simply offering employees the right to buy stock as any other investor would.

Stock options give employees the right to buy a number of shares at a price fixed at grant for a defined number of years into the future. Restricted stock and its close relative restricted stock units RSUs give employees the right to acquire or receive shares, by gift or purchase, once certain restrictions, such as working a certain number of years or meeting a performance target, are met.

Phantom stock pays a future cash bonus equal to the value of a certain number of shares. Stock appreciation rights SARs provide the right to the increase in the value of a designated number of shares, paid in cash or shares. Employee stock purchase plans ESPPs provide employees the right to purchase company shares, usually at a discount. Stock Options A few key concepts help define how stock options work: The purchase of stock pursuant to an option.

The price at which the stock can be purchased. This is also called the strike price or grant price. In most plans, the exercise price is the fair market value of the stock at the time the grant is made. The difference between the exercise price and the market value of the stock at the time of exercise. The length of time the employee can hold the option before it expires. The requirement that must be met in order to have the right to exercise the option-usually continuation of service for a specific period of time or the meeting of a performance goal.

A company grants an employee options to buy a stated number of shares at a defined grant price. The options vest over a period of time or once certain individual, group, or corporate goals are met. Some companies set time-based vesting schedules, but allow options to vest sooner if performance goals are met. Once vested, the employee can exercise the option at the grant price at any time over the option term up to the expiration date. Kinds of Options Options are either incentive stock options ISOs or nonqualified stock options NSOs , which are sometimes referred to as nonstatutory stock options.

When an employee exercises an NSO, the spread on exercise is taxable to the employee as ordinary income, even if the shares 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. Any subsequent gain or loss on the shares after exercise is taxed as a capital gain or loss when the optionee sells the shares. An ISO enables an employee to 1 defer taxation on the option from the date of exercise until the date of sale of the underlying shares, and 2 pay taxes on his or her entire gain at capital gains rates, rather than ordinary income tax rates.

Certain conditions must be met to qualify for ISO treatment: The employee must hold the stock for at least one year after the exercise date and for two years after the grant date. This is measured by the options' fair market value on the grant date. 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 qualify 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 ISOs and identifies the class of employees eligible to receive the options.

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 all the rules for ISOs are met, then the eventual sale of the shares is called a "qualifying disposition," and the employee pays long-term capital gains tax on the total increase in value between the grant price and the sale price. The company does not take a tax deduction when there is a qualifying disposition. If, however, there is a "disqualifying disposition," most often because the employee exercises and sells the shares before meeting the required holding periods, the spread on exercise is taxable to the employee at ordinary income tax rates.

Any increase or decrease in the shares' value between exercise and sale is taxed at capital gains rates. In this instance, the company may deduct the spread on exercise. Any time an employee exercises ISOs and does not sell the underlying shares by the end of the year, the spread on the option at exercise is a "preference item" for purposes of the alternative minimum tax AMT.

So even though the shares may not have been sold, the exercise requires the employee to add back the gain on exercise, along with other AMT preference items, to see whether an alternative minimum tax payment is due. In contrast, NSOs can be issued to anyone-employees, directors, consultants, suppliers, customers, etc. There are no special tax benefits for NSOs, however. Like an ISO, there is no tax on the grant of the option, but when it is exercised, the spread between the grant and exercise price is taxable as ordinary income.

Electronics retailer hhgregg Inc. Terms often change along the way, as an improving or declining stock price can affect the number of eligible options and the new strike price.

An earlier version of this article misstated the name of the firm. Stock-option exchanges surged in popularity during market busts, when many options became underwater. Dow Jones, a News Corp company. News Corp is a network of leading companies in the worlds of diversified media, news, education, and information services. Retailer hhgregg repriced options with a three-year vesting schedule for 58 employees in A hhgregg representative declined to comment. For example, when considering a six and one day exchange, there is risk to the employee that the fair market value will rise as of the reissuance date; or when considering a restricted stock award a company should consider whether the employees will have the cash available to pay for the stock at the time of award.

Additionally, when considering a make up grant, a company should consider the potential unwarranted dilution to existing shareholders. Repricing of stock options should not be lightly undertaken.

A company considering repricing its stock options should consult with its legal and accounting advisors to consider all of the implications, since a repricing implicates several sometimes conflicting sets of rules. That being, said repricing often remains a necessary undertaking given the critical importance of retaining and incentivizing employees. Corporate Governance Considerations The decision of whether to undertake a stock option repricing is a matter of corporate governance for the board of directors to consider and approve.

Accounting Considerations The accounting implications are typically the most troublesome aspect of repricing stock options. Alternative Repricing Approaches Over the past year several of our clients have considered repricing their underwater stock options and we have participated in at least three repricing approaches that seek to avoid the accounting concerns described in the prior section.

Restricted Stock

A reprice is the exchange of employee stock options that are no longer in the money for options that are currently at the money. Electronics retailer hhgregg Inc. repriced options with a three-year vesting schedule for 58 employees on May 1, to the then-current trading price of $, according to a filing. Since , the stock hasn’t returned to that . “However, when employee options are repriced after a stock price decline, but investors are stuck with the lower priced stock, the alignment is gone.” She says that when talented employees are holding underwater options and are being tempted to leave, “management has to ask itself if the shareholders are better off if we reprice and keep these employees.