Hi Tami! Ooh, there's so much to know about this. First, the tax treatment will depend on where the employee is subject to tax. Let's start with the United States. In the US, the tax treatment will also depend on whether employees have incentive stock options (ISOs) or nonqualified stock options (NQSOs) and whether the options are vested at the time they exercise them.
ISOs qualify for preferential tax treatment in the US. One benefit of this treatment is that taxation for regular tax purposes is deferred until employees sell the stock they acquire under the ISO. When employees do sell, the amount and character of their income they recognize on the sale will depend on whether they've met the required holding period. The treatment is described in this NASPP Blog entry: https://www.naspp.com/blog/disqualifying-vs-qualifying-isos.
While ISOs aren't submit to regular income tax at exercise, they are subject to the alternative minimum tax. The spread at exercise will be income for AMT purposes--this could put employees in a situation where they have to pay the AMT instead of their regular tax liability. AMT is complicated and varies based on employee's individual tax situations, so it's something you want to encourage employees to talk to an advisor about (or at least run some scenarios in a tax prep software before they exercise).
NQSOs do not qualify for preferential tax treatment. As a result when employees exercise NQSOs, they will recognize ordinary income equal to the difference between the exercise price and the current value of the stock, even if they aren't selling the stock right away. The company will be required to withhold taxes on this income and report it on employees' Forms W-2. And the company is entitled to a tax deduction for it. You'll withhold all the same taxes that apply to employees' regular wages (at the federal level, that's income tax, Social Security, and Medicare).
So that's a quick summary of the federal treatment. Note that the treatment is different if employees are exercising options that aren't vested yet.
If employees live or work in states that impose an income tax, they'll likely have to pay taxes on their equity awards in those states as well. Most states follow the federal treatment, but not all. Some states, like Pennsylvania, don't recognize the concept of ISOs, so for PA state tax purposes, ISOs are taxed in the same manner as NQSOs.
Outside the US, every country has its own tax laws. There are no countries that offer preferential tax treatment for ISOs, so outside the US, ISOs and NQSOs are taxed the same. (But some countries have their own versions of tax qualified stock options.) Most countries that impose an income tax subject options to tax at exercise, but some tax options at sale or at other points (grant or vest) and sometimes there are elections employees have to make with respect to the taxation of their stock options.
And if employees are moving around during the lives of their options (e.g., from state to state, or from country-to-country), they may have to pay tax in multiple jurisdictions when they exercise their options.
If you are looking for more information on taxation of stock options, the NASPP has a great course, Equity Compensation Fundamentals - Private Companies (https://www.naspp.com/education-programs/private-companies) that covers this topic in more detail.
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Barbara Baksa
Executive Director
NASPP
bbaksa@naspp.com------------------------------
Original Message:
Sent: 06-12-2024 10:05
From: Tami Corum
Subject: Ask an Expert on Equity Compensation
Hi Barbara, I am interested in the tax implications to our company and the employees around exercising their stock options.
Thanks!
Tami Corum, CFO Burlingame Studios Inc
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Tami Corum
Original Message:
Sent: 06-05-2024 09:18
From: Barbara Baksa
Subject: Ask an Expert on Equity Compensation
Hi Carta Community!
I'm Barbara Baksa and I'm the Executive Director of the National Association of Stock Plan Professionals (NASPP). We provide education, resources, and networking opportunities for companies that offer stock compensation (stock options, restricted stock and units, etc.) to their employees. We have extensive resources on equity plan design, tax, accounting, administration, and more on our website and we host an annual conference on stock compensation. We offer a free newsletter, The Cap, that focuses specifically on equity plans at private companies.
I'll be answering your questions on equity compensation on June 12 at 10:00 AM Pacific. I am a Certified Equity Professional (a designation offered by Santa Clara University) and my expertise is in how companies use equity to compensate employees and what they need to do to keep their equity plans compliant with tax, accounting, securities law, and other requirements. Note that, while I know a lot about stock compensation, I am not a lawyer or a CPA and none of my answers can be considered legal or accounting advice.
I look forward to your questions! You can submit them now and I'll answer them when the session starts on June 12.
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Barbara Baksa, CEP
Executive Director
NASPP
bbaksa@naspp.com
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