Anthony points to a good overview on equity-based compensation. Motivation issues aside, such plans are also a key means to attract and keep top talent when you might not otherwise have the means (i.e., an early stage startup).
The article discusses the three primary forms of equity - Incentive Stock Options (ISOs), Non-qualified Options (NQOs), and a stock bonus plan.
ISOs are preferable because of the tax treatment for the recipient, but there are stricter
requirements in issuing them. A brief matrix outlining the tax implications of ISOs and NQOs is below.
| Event |
ISO - Tax to Employee |
ISO - Tax to Employer |
NQO - Tax to Employee |
NQO - Tax to Employer |
| Grant |
None |
None |
None (if close to FMV) |
None |
| Exercise |
None |
None |
Ordinary Income |
None |
| Sale of Stock |
Capital gains above exercise tax |
None |
Complicated (if held for 2 years, capital gains only) |
None |
As I briefly discussed with regard to the options scandals, the goal is to postpone and potentially lower the tax to the recipient.