Follow Adam Linkedin Twitter Facebook
Email Adam Email
Financial
Jan 2, 2017

How To Incentivize Employees With Equity Ownership

Sponsored Content provided by Adam Shay - Managing Partner, Adam Shay CPA, PLLC

As we've seen more scalable startups in the Wilmington area, we've received an increase in inquiries as to how to incentivize employees with equity ownership. 

There are a couple of different ways this can be accomplished, and each approach has different tax treatments.

We'll cover some of the tools available, but the devil is in the details so we really recommend working closely with an experienced attorney that is collaborating with your CPA firm as part of this process. 

With a lot of these, equity incentive approaches require a 409A valuation to take place, which can mean an additional cost of putting them in place.

If you are starting a company from scratch and you think there is a possibility you are going to offer equity to future employees or bring in external investors, we recommend you set up a corporation and not an LLC. The reason for this is a corporation can bring in additional owners by issuing additional shares. This will avoid triggering adverse tax consequences for the existing owners that would occur under an LLC structure.

There are a couple of different ways to offer equity-type ownership to employees. I've listed them in the order in which we most commonly see them.

Stock Options

With stock options, there typically is no tax for the recipient when granted, but there is at a later time (when and what type depends upon the option type). The employer typically does not get a tax deduction with stock options. Converting options to shares is referred to as the exercise of the options. The exercise occurs at a price- the money that must be paid for the shares of stock.  There are two types of stock options - nonqualified stock options (NQSOs) and incentive stock options (ISOs). 
  • Incentive Stock Options (ISOs) - These are often referred to as qualified stock options since they qualify to receive favorable tax treatment.     There is no tax at the exercise of these options. If you sell the stock purchased via the options at least two years from the date the option was granted and as well as hold the actual stock for at least one year, then the difference between the stock sale price and the option exercise price is treated as favorable long-term capital gains.
  • Nonqualified Stock Options (NSQOs) - There are no favorable tax treatments for NSQOs.  There is no tax upon the grant of the options, but the difference between the grant and exercise price is taxed as ordinary income.

Restricted Stock

This is typically the issuance of shares to an employee which does not occur until some sort of restriction is listed, whether that is length of service restriction or company or individual goals restrictions. 
 
As far as taxation, the employee typically has a choice to make at the grant time. The employee can choose to make an 83b election within 30 days of the restricted stock grant and recognize the stock as ordinary income at the time it is granted. With a growing startup, this typically results in a lesser tax hit for the employee as the stock's value will continue to grow. The risk is that the employee could have taxable income on stock that is worthless down the road. 
 
The other option is for the employee to wait for the restriction to be lifted, at which point the stock received gets recognized as ordinary income at that time.  The employer gets a tax deduction on any amount the employee pays taxes on.
 

Phantom Equity

Phantom equity can allow employees to receive some of the benefits of an exit without owning actual shares of the company. This approach is typically covered in an employment contract.

For example, if Bob works with the company for three years and is still with the company when an exit event happens, he would receive income equal to 5 percent of the company's sales price. This would be ordinary income to Bob and would be a tax deduction for the business.
 

Other Flavors Available

Employees can receive stock as compensation without restrictions or have the ability to purchase shares within a company.
 
My goal today was to give you an overview of some of the equity compensation tools available to scaling and growing companies.  There are a lot of considerations to factor in, so again we strongly recommend that you work with a professional when considering your options, no pun intended.

Adam Shay, CPA (N.C. License Number 35961), MBA, is managing partner of Adam Shay CPA, PLLC. He focuses on minimizing taxes and improving the financial results of entrepreneurs, and is actively involved in supporting the Wilmington entrepreneurial and startup community. For more information, visit http://www.wilmingtontaxesandaccounting.com/ or email him at [email protected]. He can also be reached by phone at (910) 256-3456.

Other Posts from Adam Shay

Adam shay blk 52015121549
Ico insights

INSIGHTS

SPONSORS' CONTENT
Cfss headshots parker robert webversion 21422121214

23 Reasons to Go Solar in 2023

Robert Parker - Cape Fear Solar Systems
Billcoleman lopw headshot

Reaping The Benefits Of Patience

Bill Coleman - Live Oak Private Wealth
Dallasromanowski headshotcopy

Building Value Outside the Business

Dallas Romanowski - Cornerstone Business Advisors

Trending News

Avelo Plans New Florida Nonstops Out Of ILM

Miriah Hamrick - Mar 30, 2023

Wawa Gas Station Proposal On City Planning Agenda

Staff Reports - Mar 30, 2023

Despite Banking Headwinds, NCino Reports Steady Growth In Sales

Jenny Callison - Mar 29, 2023

Riverfront Farmers’ Market Returns To Dock Street For 20th Season

Miriah Hamrick - Mar 29, 2023

Tech Roundup: New Software Platforms, STEM-ILM Event And Tech Awards Deadline

Johanna Cano - Mar 29, 2023

In The Current Issue

New Makerspace Is Born

Doug Hamerski is a nephrologist who likes to spend his free time on other sciences, from circuity to radio. This pastime has now grown to a...


Brunswick Rides Wave Of Tourism Boost

This spring, new TV advertisements for Brunswick County’s island beaches will run in markets across the mid-Atlantic region, including citie...


Southport Brisket By Way Of Texas

Open since April 2014, Southport Smoke House has been introducing guests to owner Troy Knight’s home state of Texas brand of barbecue: beef...

Book On Business

The 2023 WilmingtonBiz: Book on Business is an annual publication showcasing the Wilmington region as a center of business.

Order Your Copy Today!


Galleries

Videos

2023 Power Breakfast: Major Developments