34 SEPTEMBER / OCTOBER 2017 HUMAN RESOURCES Multiple options exist for equity-based compensation. Choosing a plan that is the right fit for your institution depends on several factors, including the related tax implications. Banks often implement equity-based compensation plans in order to attract new talent, to motivate employees and executives, and to reward high performers for results. Among the most popular types of equity-based compensation plans are incentive stock options (ISOs), nonqualified stock options and restricted stock. Overall, each of these plans has a positive impact, but choosing the one that’s right for your institution depends on factors unique to your institution and the employees you are rewarding. Nonqualified Stock Options When a nonqualified stock option is exercised, the amount by which the fair market value of the stock at the time of exercise exceeds the exercise price (the “spread”) is reported as taxable wages. For the employee, the spread is subject to federal income tax in the year of exercise. After exercise, the employee owns the shares, and the shares can be sold at any time. Upon the sale of the shares, any gain recognized during the period the shares are held will be treated as a capital gain (or loss, if sold at a loss) for income tax purposes. Bank tax impact: The institution receives a federal income tax deduction at the time of exercise for the spread that the employee includes in personal taxable income. Incentive Stock Options ISOs are generally preferred by eligible employees, since they are not included in employees’ wages for income tax purposes at the time of exercise, unless a disqualifying disposition occurs, as later discussed. There are several restrictions for an option to be considered an ISO, including but not limited to meeting the following criteria: • ISOs must be granted by a plan that specifies the number of shares to be issued on exercise of the options and the classes of employees eligible to receive the options; • The plan must be approved by shareholders within 12 months before or after its adoption; • Options must be granted within 10 years after the earlier of the adoption of the plan or the date of shareholder approval; • Generally, options cannot be granted to an individual owning more than 10 percent of the combined voting power (limited exceptions apply); • The exercise period is generally limited to 10 years after grant; • Terms of the option must specify that it is not transferable to any person other than the employee during his or her lifetime. When ISOs are exercised, the shares must be held for at least one year from the date of exercise and two years from the date of grant in order for the employee to receive favorable tax treatment. If shares are sold prior to the end of these holding periods, a disqualifying disposition occurs, and the difference between the fair market value of the stock and the exercise price becomes taxable income for the employee. It is the responsibility of the institution to track the holding period to determine if a disqualifying disposition has occurred. If the shares are disposed of in a disqualifying disposition, the institution has certain tax reporting requirements for the employee’s W-2. Recruit and Motivate Staff With equity-based compensation plans Plante Moran is a Diamond Associate Member of the Indiana Bankers Association. Article author Brian M. Howe Partner Plante Moran brian.howe@ plantemoran.com
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