Employee Stock Options – The Basics You Should Know to Incentivize Key Employees with Stock Appreciation Rights

  • by Pat
  • 28 Days ago
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Stock appreciation rights

Looking to reward key employees or managers with company stock options?

It’s a good idea to develop ways to reward and retain talent in your organization and, one of those ways is by issuing stock options to your key employees.   More and more companies are offering stock options to their employees as a way to align their efforts with that of the organization and other stakeholders.

This article is the third in a series that discusses the basics of employee stock options and plans.  If you didn’t catch my first two articles, I recommend you read both of them as well.

This article is about stock appreciation rights which is another way for companies to give their employees a bonus if the company performs well.  Stock appreciation rights closely resemble stock options.  As the company’s stock value increases, the employee benefits from this increase in value.  The difference between stock options and stock appreciation rights is that the employee isn’t required to pay an exercise price but they do receive the amount of the stock value increase in either cash or stock.

Stock appreciation rights, or SARs, may not have a specific payout date like options do and is taxed to the employee as ordinary income and deductible by the company when the right to the benefit is exercised.  If, however the award is paid in shares, the amount of the gain is taxable at exercise, even if the shares are not sold and any subsequent gain on the shares is taxable as capital gain.

Careful consideration should be given to the overall plan development as companies need to figure out how they will pay for the SARs.  Will it be paid in cash or stock and, how will it be funded?  Also, is there an irrevocable promise of the payout made to employees?  If so, this could cause an unintended tax consequence where an employee could have to pay the tax before the payout.

If the SAR is set-up to benefit most or all employees and defer payments until termination, it could be construed as a plan regulated by ERISA or the Employee Retirement Income Security Act of 1974.  This is a federal law which disallows non-ERISA plans to be setup and handled like a real ERISA plan such as a 401k or 403b.   As with any type of employee incentive plans, proper planning and obtaining guidance from a knowledgeable professional will avoid many of these problems.

Be sure to check back next month for my 4th article in this series to learn more about stock transfer plans for closely held organizations.  For more information on this and other tax and accounting topics visit my website at actservices-inc.com.

Read more articles by Tina Moe at Tina Moe, CPA owner of ACT Services contributor archive page.