(ERISA). One of ERISA’s requirements is that the equity award be granted pursuant to a written plan document that contains, among other requirements, details about eligibility for the award and information on vesting. Employers should consult with their ERISA counsel to ensure any equity compensation they intend to grant compiles with (or is exempt from) not only IRC Section 409A, but also ERISA. Advantages, Drawbacks & Taxation of Equity Compensation Award Alternatives A. Restricted Equity Restricted equity awards grant employees actual ownership in the company on the grant date so, at that time, employees hold distribution and equity owner rights. Typically, the employee does not pay anything for the restricted equity award. The equity is restricted in that, until the restrictions lapse (i.e., when the equity vests), the shares or units are subject to forfeiture (typically on the termination of employment) and are non-transferable by the employee. 1. Advantages to restricted equity awards include the following: • The service provider is granted actual ownership in the company on the grant date, which can have retentive effect. • The service provider has flexibility in electing when to be taxed (as discussed below). • The awards do not include an exercise feature requiring a service provider to come up with cash to pay an exercise price. • No valuation or appraisal of the value of the company’s stock is necessary. 2. Disadvantages to restricted equity awards include the following: • Time-vesting awards reward only aggregate company growth and not necessarily individual or business unit performance (when compared to, for example, an incentive bonus program). • The current owners’ holdings are diluted by the service provider’s award upon grant. 3. Taxation of Restricted Equity Restricted equity awards are categorically exempt from IRC Section 409A and are generally not subject to income tax to the employee at the time of grant. Instead, the service provider recognizes ordinary income on the excess of the fair market value of the equity on the vesting date over the amount paid, if any. Alternatively, within 30 days of the grant date, an employee may make an election under IRC Section 83(b) to be taxed at the time of grant. If such an election is made, the employee recognizes ordinary income on the excess of the fair market value of the equity on the grant date over the amount paid, if any. B. Equity Options Equity options (including non-qualified stock options (NSOs) and incentive stock options (ISOs)) provide employees with the right to purchase company equity at a specified price (the exercise price) in the future when the option vests. Only C corporations may grant ISOs, and ISOs may only be granted to employees. ISOs receive favorable tax treatment if certain requirements are met (as discussed below). For entities taxed as Continued on page 18 ► NESCPA - Half Page Ad.indd 1 10/26/21 4:33 PM 17 www.nescpa.org
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