DUE TO RECENT TRENDS IN THE LABOR MARKET, INTEREST IN offering equity compensation as a way to compete for and retain talent has grown quickly. Equity compensation is a payment in company equity typically granted to key employees and can act as a beneficial tool for companies looking to attract, retain, and incentivize top talent. While the advantage of providing equity compensation packages is clear from a business perspective, there are important legal implications to consider. This article discusses the advantages, drawbacks, and tax and business considerations of the most common forms of equity compensation, including (1) restricted equity; (2) equity options; (3) phantom equity; and (4) profits interests. For purposes of this article, “equity” is used broadly to refer to stock, units, partnership interests, or membership interests, depending on the state-law entity type involved. General Considerations for Equity Compensation When exploring the type of equity compensation to offer and the characteristics of the same, companies should be mindful of the following general principles: Entity Type Limitations. While any entity can grant equity compensation, not all forms of equity compensation are available to every type of entity. There are major differences in the awards that can be offered between entities taxed as partnerships, S corporations, and C corporations. EQUITY COMPENSATION AS A TOOL FOR RETAINING KEY TALENT: TAX CONSIDERATIONS BY HANNAH FISCHER FREY MORGAN L. KREISER & CARRIE SCHWAB, BAIRD HOLM LLP Governing Documents. It is important for the issuing entity to review its governing documents to ensure the equity will be held as the current owners intend. This is often a good time to review and possibly revise voting thresholds, transfer restrictions, redemption rights, and the like. Vesting. Depending on the type of equity, the issuing entity may be able to subject the award to vesting based on (1) the passage of time; (2) the option holder’s continued service with the company; (3) the achievement of specific performance criteria; or (4) a combination of the above. Generally, the equity can vest all at once or pursuant to a schedule set forth in the award agreement or similar documentation. Section 409A Compliance. Equity compensation, regardless of its form, is taxed to the employee or service provider as wages, unless an exception specifically applies. Because equity compensation is often subject to vesting, the taxation of the compensation can sometimes be deferred to a later tax year. Section 409A of the Internal Revenue Code (IRC) governs nonqualified deferred compensation, including many types of equity compensation. IRC Section 409A imposes immediate taxation, plus a 20% excise tax, to the service provider on any nonqualified deferred compensation that does not comply with or meet an exception under IRC Section 409A. Ensuring compliance with IRC Section 409A (or one of its exceptions) is accordingly imperative when granting equity compensation. ERISA Compliance. Equity compensation awards may be subject to the Employee Retirement Income Security Act of 1974 16 Nebraska CPA
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