Executive stock options and stock appreciation rights


  1. Author Corner
  2. Executive Stock Options And Stock Appreciation Rights Employment Law Series
  3. Stock Appreciation Right (SAR)
  4. "Stock Appreciation Rights and the SEC: A Case of Questionable Rulemaki" by Stuart R. Cohn

The tax due will likely be paid from the cash generated during the exercise via a tax withholding. Again, stock appreciation rights differ from non-qualified stock options in that SARs are often paid in cash. There are some exceptions, and plans that issue stock does exist — but for the most part, exercising SARs will leave you with cash. Exercising and receiving cash is important because it creates a different impact on your investment allocation and concentration risk than if you exercised non-qualified stock options and received the stock.

In fact, you could consider SARs that settle in cash as a kind of forced decision to diversify assets. To buy additional shares of stock would take an intentional effort on your part. You would need to take the cash you received and buy shares of stock.

Author Corner

There is no guarantee that SARs that settle in cash or stock options that settle in stock is the better answer, however, so you should still work with someone to ensure you allocate your cash wisely after receiving it. Stock appreciation rights look similar and operate very similarly to non-qualified stock options.

For this reason, many of the planning considerations remain the same. Many of the answers to these questions will be the same as they are for employee stock options. A good financial strategy around when to exercise your SARs and what to do with the cash once you exercise is something that should be developed along with your financial plan. Diversification does not guarantee a profit or protect against a loss.

None of the information in this document should be considered as tax advice. You should consult your tax advisor for information concerning your individual situation. Projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Tax services are not offered through, or supervised by, The Lincoln Investment Companies. GREAT overview! The intent of the IRM in turn appears to be to mitigate the practical, logistical challenges employers face in the context of a pristine application of those rules and provide administrative relief subject to the satisfaction of certain conditions.

Finally, please note that the application of the income inclusion and FICA and FIT withholding and deposit rules can vary depending on the specific terms and conditions of the equity award grants.

Executive Stock Options And Stock Appreciation Rights Employment Law Series

Further, the deposit obligation rules and related FTD penalties are significantly more complex than the One-Day rule discussed in the new guidance. To ensure compliance with the FIT and FICA withholding and deposit rules as applied to more complicated equity awards, and to avoid the application of FTD penalties on equity awards generally, we recommend that companies consult with their executive compensation and employee benefits advisors. Situation 1 involves a grant to an employee of nonstatutory stock options with no ascertainable fair market value on the date of grant.

The IRS reaffirms its long held position that the fair market value minus the exercise price of shares of stock transferred to an employee pursuant to a stock option are includible in income under Code Section 83 on the date that the employee exercises the option. Situation 2 relates to a grant of stock-settled SARs to the employee. Under the facts of the GLAM, upon exercise of an SAR, an employee is entitled to the number of shares of employer stock equal to the difference between the fair market value of a share of such stock on the date of exercise over its fair market value on the date of grant, divided by the fair market value of a share of such stock on the date of exercise.

The fair market value of the shares received on the date of exercise is includible in income by the employee and constitutes wages paid subject FICA and FIT. One of the most interesting tools developed for this purpose is referred to as a "rabbi trust.

Stock Appreciation Right (SAR)

A "rabbi trust" is an irrevocable trust which, because of administrative powers retained by the grantor employer, is treated as a grantor trust under IRC Sections The grantor employer is treated as the owner of the trust for tax purposes. In such a trust, the trustee is a fiduciary who receives assets contributed by the employer to support the employer's deferred compensation obligation. By the terms of the trust, the assets can be utilized only to pay the promised deferred income or to pay claims of the employer's creditors.

After a series of private rulings involving "rabbi trusts" for executives PLRs , , , and , a hiatus ensued before the IRS resumed giving private letter rulings with PLR The procedure provides implicit approval of such arrangements so long as certain criteria are met. Although rabbi trusts do provide the employee with substantial comfort, particularly the risks inherent with changes in management, they cannot protect the employee from the insolvency risk of the employer without triggering immediate tax. If language other than the model language is used, obtaining a private ruling may be prudent.

Secular Trusts. A recent variation on the "rabbi trust" is a so-called "secular trust.

"Stock Appreciation Rights and the SEC: A Case of Questionable Rulemaki" by Stuart R. Cohn

The employee however has the benefit of a secured obligation. See PLRs , It should be noted that under recent private letter rulings, earnings on assets held in a secular trust may be taxed to the beneficiaries as earned unless the plan and trust are structured to include a substantial risk of forfeiture. Also, care should be taken in designing and drafting secular trusts to avoid tax to the sponsor, if not desired. See PLRs , , , and Phantom stock plans are generally grouped into the following two 2 broad categories: Phantom Stock Appreciation Plans.

These plans primarily permit an employee to participate in the appreciation if any of a company's stock. These plans credit to an employee's account the value of the company stock and permit the employee to participate in the appreciation of the stock. The Code generally provides that a cash basis taxpayer such as an employee is not required to include in income an unfunded or unsecured promise to pay money or property in the future. Accordingly, so long as the phantom stock plan is an unsecured obligation of the company to pay money or stock in the future, an employee should not be required to include the phantom stock in income until the employee actually receives payment.

When phantom stock is paid to an employee, the payment will generally be treated as compensation income. Accordingly, employees will not be able to take advantage of capital gains, and the payments will generally be subject to withholding. The employer is allowed a compensation deduction when it actually pays an employee under the phantom stock plan. Additionally, because the payment is considered compensation, the employer generally would be required to withhold income tax and employment taxes.

The employer also must match the FICA i. Non-Lapse Restrictions. Only the combination of a substantial risk of forfeiture and "non-transferability of stock" permit the postponement of the taxable event. Restrictions which will never lapse do not work to postpone the taxable event under Section Although such "non-lapse" restrictions may affect the amount of income to the stockholder recipient, they do not defer the taxable event. The regulations provide that a "non-lapse restriction" is a permanent limitation on transferability requiring the holder to sell at a formula price and which will apply as to any transferee.

A formula price buy back on termination of employment is a non-lapse restriction.

Generally, there is no tax on the grant of restricted stock so long as shares are restricted. The recipient's basis is equal to the amount paid for the stock. Lapse of Restriction. Generally, an employee receiving restricted shares of stock in connection with the performance of services will incur tax liability at the time those shares become unrestricted. For the taxable year in which some or all of the shares become unrestricted, the employee will recognize ordinary income in an amount equal to the fair market value of the shares at the time the shares become unrestricted less the amount, if any, paid for the shares when they were received.

This is true irrespective of whether the employee sells or retains the shares at the time they become unrestricted. Tax on Unrecognized Appreciation.

Explained: Stock Options, Stock Appreciation Rights \u0026 Depository Receipts

In the event the fair market value of the shares has increased substantially between the time the shares were received and the time they become unrestricted, the tax consequences of Section 83 a can be quite harsh. Shareholders may thus find themselves compelled to sell their shares in order to pay this tax on ordinary income at an inopportune time.

Use of 83 b Election. The harsh result under Section 83 a can be mitigated by making a timely election under the provisions of Section 83 b. A shareholder who elects the tax treatment of Section 83 b "an electing shareholder" recognizes ordinary income at the time the shares are received even though they are restricted shares. This ordinary income will equal the fair market value of the shares less the amount, if any, paid for the shares. If shares received by the electing shareholder are of a relatively low fair market value for example, a start-up business with minimal capitalization , an electing shareholder using Section 83 b will generally incur a minimal amount of income tax.

Because a shareholder electing under Section 83 b recognizes ordinary income in the year the shares are received, a Section 83 b election can provide substantial tax advantages in later years. A shareholder making the election will recognize no income in the years in which the shares become unrestricted. Capital Gains. Income recognized on disposition will be taxed as capital gains.

If the stock is held long enough, the employee can take advantage of the maximum benefit of lower capital gain rates. An election under Section 83 b is especially attractive in the context of an early stage, emerging growth company because the appreciation in the value of the stock may be quite significant. In addition to the tax consequences on the shares themselves, the decision whether to make an election under Section 83 b will also affect other aspects of a shareholder's tax situation.

A non-electing shareholder must hold the shares one year after they become unrestricted shares in order to receive long term capital gains treatment on any sale of those shares. Any tax liability on the sale of the shares is in addition to the tax which must be recognized by a non-electing shareholder on the date the shares become unrestricted. The holding period for an electing shareholder is one year from the date on which the shares were first received.