Stock and Restricted Stock Equity

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Stock Options and Restricted Stock Equity Andrew T. Mirsky Mirsky & Company, PLLC Mirsky & Company, PLLC (“Kenyon”) has provided this presentation for general informational purposes only. It is not intended as professional counsel and should not be used as such. You should contact your attorney to obtain advice with respect to any particular issue or problem.

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Ever wonder what the pros and cons to stock options are? Well, wonder no more- that information is here for you! In addition, this presentation provides valuable information for both emploees and employers and fast facts about non-statutory or non'qualified stock options which may be issued to employes as well as non-employees such as contractors and freelancers. Andrew Cooper, CPA (Quinn Lobel & Associates, P.C.) co-hosts.

Transcript of Stock and Restricted Stock Equity

Stock Options and Restricted Stock Equity

Andrew T. Mirsky Mirsky & Company, PLLC

Mirsky & Company, PLLC (“Kenyon”) has provided this presentation for general informational purposes only. It is not intended as professional

counsel and should not be used as such. You should contact your attorney to obtain advice with respect to any particular issue or problem.

Andrew T. Mirsky, Esq.

• Principal, Mirsky & Company, PLLC, DC and NY

• Formerly in-house counsel with National Journal and Atlantic Monthly magazines

• Clients in new media and technology, including intellectual property, corporate and finance, privacy, joint ventures and partnerships, and employment and HR matters.

• Founder, Media Future Now (www.mediafuturenow.com)

Two Types of Stocks

•Incentive ISOs (Incentive)

•(Non-statutory or Nonqualified) NSOs

Who May Receive?

ISOs

• Employees only (and must be exercised within 3 months of leaving company)

NSOs

• Employees and contractors and anybody else. NSOs can be given to anyone, including vendors, partners, freelancers, your mother … anybody.

Pricing ISOs

Must be granted at (or above) fair market value. (Section 409A Rules)

NSOs

Can be priced below (or above) current market value.

Holding Period

ISOs

1+ year from exercise and 2+ years from grant. Required.

NSOs

none, BUT: if disposition occurs prior to 1 year after exercise, taxed at ordinary, not cap gains.

When taxable to recipient?

ISOs

• Not taxable upon grant. Not taxable upon exercise. Taxable only upon disposition of underlying stock, and at (more favorable) capital gains rate. Therefore: If never exercised, never taxable.

NSOs

• Not taxable upon grant. Taxable at exercise (ordinary) based on spread between exercise price and FMV. Taxable upon disposition (cap gains or ordinary), and at higher basis than ISO.

What Type of Tax?

Taxable upon disposition (not exercise) at capital gains rate, based on appreciation between exercise price and price at disposition.

ISOs

Taxable at exercise as ordinary income, and taxable upon disposition at capital gains rate.

NSOs

Deductibility (for Company)

ISOs

Not deductible as compensation

NSOs

Company gets deduction (at exercise, not grant). This can be significant.

When Exercised

ISOs

Must be exercised within 3 months of termination of employment

(otherwise, gets treated as NSO.

NSOs

No limitation.

AMT

ISOs

•Potentially Problematic

NSOs

•Practically speaking, not affected.

Restricted Stock

Restricted Stock

Stock (i.e. actual stock, not options) that is “substantially nonvested”, meaning:

Subject to “substantial risk of forfeiture”, i.e. subject to repurchase at less than FMV if employee leaves Company and “non-transferable” without risk of forfeiture.

Grantee is true “shareholder” with all rights of owners (voting rights, distribution rights, information rights, etc.).

Who May Receive?

• Contractors

• Freelancers

• Vendors, etc.

Employees and non-employees

Pricing

If stock has value

• employee required to pay $$ for purchase (unlike options)

• Otherwise, grant = compensation

However, with new companies with startup value

• stock may not yet have value, so cost may be negligible.

Holding Period

• forfeiture and repurchase terms allowing buyback at cheap cost if grantee leaves company during “holding” period

Typically

• possible shareholder restrictions on transferability

As with any stock ownership

When taxable to recipient?

No income tax upon grant until vesting restrictions lapse

Then tax as compensation at ordinary income rate

Section 83(b) election: Grantee may elect or recognize income immediately (rather than post-vesting and post-appreciation) upon grant based on FMV of underlying stock

• Downsides: 1. pay tax now, but at a potentially lower rate than later and 2. potential forfeiture

Deductibility (for Company)

Does the Grantee make 83(b) election?

If yes:

• Company gets deduction for compensation.

No?

• Then company gets deduction when restrictions relapse

Q+A

Q: AMT implications – how might the AMT be increasingly reducing tax benefits of ISOs? Is

this true?

Q+A

A: Yes, it’s possible. For ISOs, benefits of (a) no tax on exercise and (b) deferred tax until

disposition possibly offset by obligation to pay AMT based on disposition. Additional problem

of difficulty to calculate.

Q+A

Q: Section 83(b): S corps often require restricted stock recipients to make 83(b) election.

(Otherwise, employee owns stock and may be legally entitled to all rights as a shareholder

(including distributions), but may not be responsible for taxable share of profits.) So, requiring 83(b) election causes employee to

recognize income now and thus dilutes taxable income of all owners.

Q+A

A: (If recipient does not make a Section 83(b) election, he or she is not deemed to own the

stock for tax purposes until vesting. Any distributions made with respect to the stock before vesting are treated as compensation

payments. If the corporation is an S corporation, the recipient does not report any of the

corporation’s undistributed income, even though he or she might be entitled to receive a

share of the income if later distributed.

Q+A

A (cont.): It is not unusual, therefore, for S corporations to require recipients of restricted

stock to make Section 83(b) elections. Absent a Section 83(b) election, the shares are not

treated as being outstanding for S corporation qualification purposes until they have vested.)

Q+A

Q: Are these the only ownership options for employees?

Q+A

A: No

Q+A

Q: What about founders – what kind of ownership?

Q: What about vesting and forfeiture?

Q: What kinds of companies can issue stock options? LLCs? S corps?

Q+A

Q: Why would a company not want to issue NSOs? Since company gets a deduction for compensation, wouldn’t this be attractive?

Q+A

A: LLCs. Options difficult with LLC “membership interests”, and ISO tax treatment not IRS-

recognized for LLCs.

Restricted stock structure more flexible than options, since options must comply with IRS

rules.

Q+A

Q: (Company perspective) Under what circumstances would a company want to issue restricted stock in preference to stock options?

Q+A

A: (1) Gives employees better sense of true, immediate “ownership”, (2) less cumbersome

than dealing with IRS option rules (e.g. FMV and Section 409A valuation rules), (3) somewhat easier to tailor transfer and other restrictions

Q+A

Q: (Company perspective) Under what circumstances would a company want to issue stock options in preference to restricted stock?

Q+A

A: (1) Does not actually give up ownership yet, and not having to deal with new shareholder demands,

(2) (with NSOs) company gets compensation deduction at exercise, (3) For key employees,

incentivizes success of Company and thus improve “spread” between stock value and exercise price,

(4) inability to run as a pass-through entity (S-corp) if too many stockholders), (5) requirements of x% of stockholders for approval of corporate transactions,

etc.

Q+A

Q: What is the major distinction between restricted stock and stock options?

Q+A

A: With restricted stock, grantee becomes actual shareholder immediately (but not for tax

purposes unless 83(b) election). Stock is actually issued to the employee (or non-

employee), subject to vesting and Company repurchase rights.

Andrew T. Mirsky

[email protected]

(202) 339-0303

www.mirskylegal.com

@mirskylegal

318 West 14th Street

4th Floor

New York, NY 10014

2301 N Street, NW

Suite 313

Washington, DC 20037