Type of Compensation

Description

Stock Sale for Cash or Property

Stock is sold in consideration for payment of cash or transfers of property by the employee to the company. There is no tax to the employee upon the purchase of stock. Upon the sale of stock, the employee will be subject to income taxation at capital gains rates on the spread between the sales price at the time of the sale and the purchase price as a sale of property, but will not be subject to employment taxation.

Stock Sale for Services

Stock is sold in consideration for the performance of services by the employee for the company. Under Ohio law, services must be performed before stock is issued. The employee will be subject to income taxation at ordinary income tax rates and employment taxation upon receipt of the stock for the fair market value of the stock.

Stock Grant (Unrestricted)

Stock is granted to the employee for past services subject only to applicable securities law restrictions. The employee will be subject to income taxation at ordinary income tax rates and employment taxation upon receipt of the stock for the fair market value of the stock.

Restricted Stock Grant (RSU)

Stock is granted to the employee for past services subject not only to applicable securities law restrictions, but also to restrictions for failure to meet service or performance vesting or failure to abide by employment or restrictive covenants. If the restrictions include a substantial risk of forfeiture before the stock becomes vested and if the option is properly constructed, the employee is not subject to taxation until the stock is vested or no longer subject to a substantial risk of forfeiture. Otherwise, the stock is subject to taxation upon receipt. At whatever point the stock is taxable, the employee will be subject to income taxation at ordinary income tax rates and employment taxation for the fair market value of the stock at that time.

Stock Options (ISO, NSQO)

An option to purchase stock is granted to the employee for past services. The option gives the employee the right during a prescribed period (generally known as the exercise period) to purchase a prescribed number of shares of stock for a price determined by the option (generally known as the exercise or option price).

The advantage of a stock option is that the employee is not taxed upon the granting of the option. When and how the employee is subject to taxation depends upon whether the option is a qualified or non-qualified option.

ISOs must meet certain tests, including the requirement that the option price be fair market value of the stock at the date of grant. For a qualified stock option, there is no tax incident until the stock acquired upon exercise of the option is sold or otherwise disposed. Then, the option-holder is subject to taxation for the spread between the fair market value and the option price of the stock acquired as a sale of property at capital gains rates.

All other stock options are non-qualified stock options. The option-holder of NQSO is subject to taxation upon the exercise of the option. At that time, the option-holder is subject to income taxation at ordinary income tax rates and employment taxation for the spread between the fair market value and the option price of the stock.

The option-holder may make a §83(b) election to be subject to taxation upon receipt of the option in order to increase opportunity for capital gains treatment.

Stock Appreciation Right (SAR)

The right to purchase and receive the appreciation in fair market value of stock over a base price is granted to an employee. Typically, appreciation rights are issued in tandem with stock options and may be exercised by surrendering the option. Upon surrender of the option, the rights-holder receives the appreciation in value typically in cash, but sometimes in shares of stock. At that time, the rights-holder is subject to income taxation at ordinary income tax rate and employment taxation for the value of appreciation received as compensation.

Phantom Stock/ Phantom SAR

The right to receive the economic equivalent of the same dividends and distributions, and proceeds from sale, of a share of stock that a shareholder would receive over a period of time. Typically, it is based upon the stock value, rather than net worth value, of the company. The employee’s benefit is the economic benefit received by a shareholder with respect to a number of “phantom”, or bookkeeping, shares. The most typical measure of the benefit is appreciation in value of stock over time. Other measures, especially with privately held companies seeking to be developed for sale, may be based upon dividends and other distributions paid from any asset sale, and proceeds received by shareholders from any stock-sale, of the company. The benefit is typically paid in cash or in the form of consideration received by the shareholders (such as in a stock merger or stock-for-stock exchange). If properly constructed, there is no tax incident until the benefit is paid. At that time, the participant is subject to income taxation at ordinary income tax rates and employment taxation for value of the benefit received.

Shadow Equity

Although sometimes synonymous with phantom stock, shadow equity typically is the right to receive compensation based upon the increase in net worth value, rather than the stock value, of the company. It is often based upon increase in the company’s net assets, often valuing substantial assets at fair market rather than book value. Other measures are capitalized earnings, typically on a per share basis. The benefit is typically paid in cash. If properly constructed, there is no tax incident until the benefit is paid. At that time, the participant is subject to income taxation at ordinary income tax rates and employment taxation for value of the benefit received.

Profits Interest

An interest to share in profits or in distributions of cash available from profits is granted to the employee. Because options in partnership interests and interests of entities taxable as partnerships do not received the favorable tax treatment received by stock options, profits or distributions interest are typically used for employees of partnerships and similar entities in lieu of stock options. If properly designed, the employee is not taxed upon the granting of the interest, but is only taxed to the extent that the employee received a distribution of cash or other property as a share of profits. An amount received is taxation at the time received based upon the nature of the item received passed-through.

Capital Interest

An interest to share in the proceeds upon liquidation of a company is granted to the employee. Because the granting of any such interest in a partnership or similar entity results in immediate taxation to the employee, these interests are not typically granted by entities taxable as partnerships. However, if properly structured with respect to an entity taxable as a corporation, the employee is not taxed upon the granting of the interest, but is only taxed to the extent that the employee received a distribution of cash or other property as a share of profits. An amount received is subject to income taxation at ordinary income tax rates and employment taxation.

Stock Bonus Plan

A right to participate in a qualified plan, a portion of the assets of which consist of employer stock. The plan is an individual account plan to which stock held by the plan is allocated typically based upon the participant’s compensation during each year of participation. The participant is not taxed until the stock or other assets are distributed to the participant, at which time the participant is subject to income taxation at ordinary income tax rates and employment taxation for the fair market value of the stock and other property received. However, a stock bonus plan is subject to all of the ERISA provisions regarding coverage, participation, contributions, vesting, funding, and fiduciary duties.

ESPP

Not a deferred compensation arrangement.

Employees participate in employee stock purchase plans to purchase stock of their employer (or an affiliate of their employer), typically authorizing payroll deductions to pay for such employer stock.  Such stock purchase plans grant options (often called "purchase rights" to distinguish them from ISOs and NQSOs) to employees to purchase employer stock, generally at a discounted price and without payment of brokerage costs or other fees. 

The most important feature of an employee stock purchase is that it can offer purchase rights with a purchase price as low as the lesser of 85% of the fair market value of the stock at the time of grant or 85% of the fair market value of the stock at the time of purchase.

ESOP

Not nonqualified deferred compensation. A right to participate in a qualified plan, substantially all of the assets of which consist of employer stock. An ESOP is essentially the same as a stock bonus plan except that an ESOP is to be designed and operated to hold primarily employer stock while a stock bonus plan may be designated to hold any investments including employer stock