Equity Compensation and Stock Option Grants
In addition to being paid salaries and fees employees and service providers often seek to be compensated by receiving stock in the companies they work for or provide services to. Conversely, companies often wish to issue stock as compensation, both because doing so is seen as a means of incentivizing employees/service providers to work harder, and issuing equity may be necessary if the salary being offered is below market. However companies and employees should understand that an outright issuance of stock to an employee or contractor may have an unintended tax consequence for the recipient of the stock: namely the payment of taxes on the value of the stock. For instance, if a company has a value of $1,000,000 and an employee receives stock equal to 2% of the company, that stock has a value of $20,000 (2% of $1,000,000), and the employee will have to pay taxes as if he or she had received $20,000 in salary.
This is where stock options come in. Under a stock option grant an employee or contactor is given the right to acquire stock of the company issuing the option for a price set forth in the option (i.e., an employee could be given the right to purchase 1,000 shares of stock in the company for $10.00 per share). Since the exercise price must bear a relationship to the actual value of the stock at the time the option is granted, if the company has any value the exercise price cannot be zero. Rather, on the option exercise the option holder will pay the value of the stock as of the date the option was granted. However the option holder will receive the benefit of any increase in the value of the stock from the time of the option grant.
While the issuance of an option (as opposed to the outright issuance of stock) is not a taxable event, depending on the type of option the exercise of the option may be a taxable event (i.e., the option holder may have to pay taxes on the difference between the exercise price and the value of the stock being purchased). Thus, careful attention must be paid to the type of option and its terms.