In the area of “stock option and employee ownership”, we help clients to design various compensatory plans according to the clients’ needs. The following are a few examples:
Incentive Stock Option (ISO) – An ISO is a statutory option, subject to the technical requirements prescribed in Section 422 of Internal Revenue Code (IRC). ISOs may be granted only to employees of the issuing company, including employees of its parent and subsidiary corporations. ISOs generally cannot be granted to persons who serve as independent contractors, consultants, or outside directors since they are not employees. As a prerequisite to granting ISOs, the employer must have a written option plan that sets forth the maximum number of shares that may be issued under the plan as well as the class of employees eligible to receive options. The plan must receive shareholder approval within 12 months before or after its adoption by the company’s board of directors. In addition, the option grant also must conform to a number of statutory prerequisites under the IRC Section 422(b).
Non-statutory Stock Option (NSO) – An NSO is a stock option not subject to special technical requirements for income tax purposes and may be granted to employees, consultants, nonemployee directors, or any other persons associated with the company. Taxation of NSOs is governed by the IRC Section 83. NSOs do not receive any preferential tax treatment under the IRC. An employee or a non-employee, as a service provider, who has been granted an NSO, will be subject to income tax only at the time the option is exercised, unless the IRC Section 409A applies. The amount taxed will be the spread, if any, between the purchase price and the fair market value of the stock at time of exercise. The spread on exercise of an NSO represents compensation income to the optionee and accordingly is subject to the special rules of Section 83(a) that govern the timing of income inclusion for tax purposes. Under Section 83(a), the value of property (stock) received for services must be included in income in the year the optionee’s rights to the property become “vested.” Section 83(c) provides that vesting occurs at the first time an optionee’s rights in the property (stock) are (1) transferable or (2) not subject to a “substantial risk of forfeiture.”
Employee Stock Purchase Plan (ESPP) – ESPP is an option plan which may be either statutory under the IRC Section 423 or non-statutory under the IRC Section 83. ESPPs are typically designed to give employees the opportunity to make regular, ongoing purchases of employer stock though accumulated payroll deductions, usually at a substantial discount from fair market value on the date of purchase. Because there is a high degree of tax and administrative complexity inherent in a typical ESPP, such plans generally are not adopted by private companies.
