During the hiring process, offering extra incentives and benefits can make an employer a more enticing and competitive option. One such perk could be equity compensation — non-cash benefits such as restricted stock or performance shares.
While these benefits are great to show appreciation and to boost employee retention, from a finance perspective, equity awards do have high-level tax and accounting ramifications. Equity awards can be complex and it’s important to fully understand the pros and cons before implementation.
The basics
Combined with salaries and other bonuses, distribution of equity compensation can attract high-quality talent —common at startup companies and other fledgling firms as they may not be able to pay employees market or above-market salaries. These equity benefits could yield a big payout for the employee over time.
Stock options — including non-qualified stock options and incentive stock options — performance shares and restricted stocks are all examples of equity awards. (Even crypto currencies fall under the umbrella of equity compensation.)
However, there are risks for the employee. Unlike a salary where they know exactly what they’re getting and when, equity awards can fluctuate, and employees never truly know if they will fully pay off. There are many variables that can impact total compensation — and accountant and finance professionals need to be sure they are implementing these correctly to avoid any consequences.
Awards explained
Here are a few of the equity awards that might be offered in your firm. Because of certain advanced technical aspects — such as the implications of section 409A ¬valuation — it’s very important to have a comprehensive understanding of the awards available.
Stock options are a very common employee reward, and often will offer the right to purchase company shares at a predetermined price. After being employed for a certain duration, the right may vest with time, granting employees control of the option and the right to sell or transfer. With this option, however, employees are not considered stockholders and do not have the same rights as shareholders.
Non-qualified stock options (NSO) and incentive stock options (ISO) provide certain tax advantages, including how they are reported. While NSOs are taxed as regular income, ISOs enable employees the ability to buy shares of the company stock at a discounted price with the added benefit of potential tax breaks on the profit.
Most commonly awarded in established companies, restricted stocks are nontransferable shares that require a specified vesting period that could last several years.
After certain metrics or benchmarks are met, performance shares are often granted to employees in the form of bonuses or stock options. This kind of equity award helps align the goals of managers and employees to those of shareholders.
Mistakes happen
Equity awards are regulated by state and federal laws and mistakes can happen when setting up these incentive plans.
When offering or selling stock options, they must be registered with the Securities and Exchange Commission and state securities agencies. Mistakes often happen with who gets the incentives, as they’re unavailable for former employees and additional reporting is required for consultants.
If an award has a certain time-based constraint, the employer must clearly communicate what those milestones are and how they need to be achieved — something often overlooked.
A third common mistake is the potential tax consequences if employees and companies accidentally overlook certain details. As the awards are still considered income, the recipient is responsible for any tax obligations. Because there may be withholding obligations from the employers, it’s important that these awards are taxed and reported correctly.
Get the full scope
To gain a more complete understanding of equity benefits, their payroll implications and more, the AICPA & CIMA Employee Benefit Plan Conference, at the Gaylord Opryland Resort in Nashville, will be offering two unique sessions on this complex topic. Additional conference topics include data privacy, the intersection of virtual burnout and remote work, guidance and updates from the Department of Labor and much more. The conference is open to in-person and virtual attendees and there is still time to register before the May 10 kickoff.