Taking Stock of Options and Awards
October 11, 2011I recently spoke to a freshly minted MBA graduate who was so thrilled to have had landed her first job in this tough job market, but her icing on the cake was a sign-on bonus equal to ½ of her first year’s salary. The catch to the bonus was that it was given to her in the form of a restricted stock award, so she had called me to find out the details. She was very confused, because in addition to the stock award for the bonus, she is also eligible for a restricted stock matching program AND stock grants.
Her biggest question was, “Do I own all these stocks now?” So we went down the list to clarify how each of these company stock ownership programs work. Let’s take a look:
Restricted Stock Award – Commonly used as payment method for sign-on bonuses, incentive pay, or achievement awards. The employee is actually awarded a specified amount of company stock, and also has the rights to the stock dividends. However, there is typically a vesting period (4 years in our above scenario), before the employee has true ownership of the stock. Upon vesting, the value of the stock award is considered compensation, and the value is subject to ordinary income tax, regardless of whether the employee actually liquidates the shares.
Restricted Stock Matching Award – Similar to the restricted stock award defined above, but with the requirement that the employee must place an equivalent number of personally owned shares of the company stock in a designated brokerage account. This program encourages employee ownership and is mostly found for management level and above employee status. In the case of Ms. MBA, she would have to buy 57 shares by 11/30/11 in order to receive her 57 shares of the restricted stock matching award.
Non-Qualified Stock Option Grant (NQSO) – The right to purchase company stock for a pre-determined price, called the exercise price. There is a set duration of the grant, typically a 10 year expiration. There is also usually a vesting period before the options can be exercised. The employee does not actually own the stock unless the option is exercised, and then the difference between the exercise price and the market price at that time is considered compensation and taxed as ordinary income.
If this isn’t complicated enough already, there are other forms of stock ownership that may be available through your own employer, including:
Stock Appreciation Rights (SAR) – Similar to a stock option grant, but provides the right to the monetary equivalent of the increase in the value of a specified number of shares over a specified timeframe, instead of actually having to purchase the underlying shares themselves.
Employee Stock Purchase Plan – This program offers the convenience of payroll deduction and perhaps a slight discount in price, typically 5 to 15% below market price, to purchase your own company’s stock. The discount of the stock price is taxed as ordinary income, and any gain on the stock would be considered capital gains.
Helping your employees sift through the differences between their ownership rights and tax treatment can be quite time-consuming, so HR should consider enlisting the help of a qualified financial professional who is familiar with these variations, which can help off-load this task from your busy day. At the same time, the employee gets the added benefit of speaking about their own overall asset allocation with a financial professional to make sure there is not too much over-weighting in company stock as part of their total net worth.