Planning for Retirement Needs

Transcription

1 Planning for Retirement Needs Equity Based Compensation Plans Chapter 16

2 Chapter 16: Equity Based Compensation Why equity based compensation Nonqualified stock options Incentive stock options (ISO) Employee stock purchase plans Restricted stock, phantom stock, SAR

3 Reasons for Equity-based Compensation Employee-owners have incentive align interests of employer/employee Employees get piece of the action Less costly than cash Tax-advantage (may get capital gains) Can include performance criteria Start-up companies cash is short Not subject to qualified plan requirements

4 Assessing The Closely Held Business Stock valuation Mechanism for repurchasing stock Placing employee at risk Tax consequences Corporate structure Legal and accounting aspects

5 Nonqualified Stock Options Options granted for a specified period at a set (usually current market value) price At exercise, participant purchases stock Ordinary income that is difference between option price and market price at exercise Employer gets a deduction in this amount Long- or short-term capital gain from time of exercise to time of sale

6 Nonqualified Stock Options Employer grants Ellie right to purchase 500 shares of common stock at current market price ($20) any time over next 10 years. After 3 years Ellie purchases all 500 shares. Price has risen to $60/share ($30,000). Ellie pays $10,000 for stock and has $20,000 of ordinary income. Employer gets $20,000 deduction Ellie sells in 2 years for $100 a share she has $10,000 of long-term capital gain

7 Nonqualified Option Design Option duration common ten years Impact of termination shortens duration Vesting provisions cliff or graded Cashless transactions broker handles purchase and subsequent sale of stock with no cash outlay from participant

8 ISOs (rules) Option price is equal to or greater than current market value Duration can not exceed 10 years Approved by board of directors $100,000 limit per employee per year 10% shareholder price must be 110% Can not be transferred

9 ISOs (Tax treatment) No income tax at time of exercise however tax preference item for AMT Tax at time of sale long-term capital gain if holding-period requirements met 2 years from exercise grant and 1 year from exercise Example: grant 1/1/09, exercise 10/1/09 sell stock 6/1/11 No employer deduction if holding period requirements are met

10 ISOs (rules) Alex, receives an ISO for 1,000 shares of company stock. The exercise price of the options is $10. One year later, Alex exercises his ISOs and receives 1,000 shares of stock. Alex holds these shares for another 2 years and then sells them for $15 per share. At that time Alex has a long-term capital gain of $5,000 (1,000 $5).

11 Choosing a Plan Employer may prefer nonqualified due to tax deduction Employees prefer ISO tax treatment Employer can establish nonqualified and provide bonus to simulate ISO tax

12 Exercising Strategies Know what type of options and terms of program Make a long-term liquidation plan Factors in making a plan include Consider holding to end of period as stocks generally rise Countervailing diversification, need cash, price not rising Consider NQSO bonus and sell at exercise On the other hand exercise early and hold to get cap. gans Consider exercising over time to get price averaging and reinvestment over time

13 Gifting ISOs must be nontransferable (no gifting) Nonqualified options may be transferable Gifting removes value from estate Example: Dan receives 500 shares at $20 a share. Gifts to son Peter after 3 years at $60 who exercises 5 years later at $120 Dan makes gift of $30,000 ($60 x 500) Peter pays $10,000 for stock ($20 x 500) Dan has taxable income of $ 50,000 ($120 -$20 x 500) Peter has cost basis of $60,000 ($10,000 + $50,000)

14 Employee Stock Purchase Plans Code Sec 423 discount program requirements Include full-time employees with 2 years of service Approved by stockholders Exclude 5% owners $25,000 per year purchase limit Valuation/accounting/securities law/administrative issues

15 Employee Stock Purchase Plans 15-percent discount Can be price at beginning of period Or price at end of purchase period No tax until sale of stock Long-term capital gain if holding period met 2 years from grant 1 year from purchase

16 Employee Stock Purchase Plans Value of discount 15-percent discount = 17.6% return Example Stock value $10 purchase for $8.50 $1.50 return on $8.50 investment is 17.6% Look-back price can be more valuable

17 Restricted Stock Executive granted shares of stock Title identifies forfeiture events (vesting) Dividend can be paid More secure than typical deferred comp. No cost to employee Taxed at time risk of forfeiture lapses Sec. 83 election to tax at time of grant

18 Restricted Stock Example: Company grants to Billy Bigshot 200 shares of stock worth $10,000. The stock will be forfeited unless Billy works until age 65, at which time the stock becomes freely transferable by Billy. At age 65, Billy retires and decides to hold the stock, which is now valued at $8,000.

19 Phantom Stock No actual stock simply bookkeeping entry Value of the units generally equals the market value of the underlying stock Fixed maturity date Could credit account with dividends Payout usually based on the appreciation in value of the stock No cost to employee

20 Phantom Stock Example: Employer grants Executive A 100 shares of phantom stock valued at $5,000 ($50 per share). The phantom stock matures, and 5 years later its value has increased to $7,500 ($75 per share). At that time, the employer pays the employee $2,500, the difference between the value at the time of the grant and the value at the time of maturity.

21 Stock Appreciation Right Right to receive increase in value of stock during a specified period Can exercise SAR during option period Example: Wanda has SAR for 1,000 shares at $100 a share Exercise 100 when value rises to $110 Exercise 900 when value rises to $200 Employee ordinary income, employer receives deduction

22 Vocabulary nonqualified stock options (NQSOs) incentive stock option (ISO) Sec. 423 stock purchase plan phantom stock restricted stock plan stock appreciation rights

23 True/False Questions 1. One problem with equity-based compensation is that benefits are always taxed as ordinary income. 2. One benefit of equity-based compensation is that it can include performance incentives. 3. George has one nonqualified stock option with an option price of $10. If George buys the stock when the market value is $50, George has $50 of ordinary income and the employer receives a deduction of $ Restricted stock provides more benefit security than other forms of deferred compensation.

24 True/False Questions 5. A phantom stock plan typically provides an award based on the appreciation in the value of stock on a specified maturity date. 6. One disadvantage of an ISO is that the employer generally does not receive a tax deduction for benefits provided. 7. ISO s may subject the executive to the AMT tax. 8. Stock purchase plans under Code Sec. 423 are similar to ISO s in that the program can be designed for a small group of executives. 9. A Code Sec 423 plan can offer the employer s stock at a 15% discount.

25 Chapter 16 Review Equity based Align er and ee interests Cheaper than cash Some taxed as capital gains Performance criteria Nonqualified stock options Employee has ordinary income at exercise Employer receives deduction Tax difference between price and cost Be ready to calculate tax ISO Generally no tax at exercise but is AMT item Capital gains if holding period 2 years from grant 1 from exercise No er deduction if cap gains 423 program Cover full-time ees with 2 years service Generally large ers 15% discount at beginning or end of purchase period No tax at exercise only at sale Cap gains holding period

26 Chapter 16 Review Phantom stock Bonus based on stock appreciation No cost to employees Employees have ordinary income er gets deduction Restricted stock Titled in name of exec Tax when restrictions lapse unless Sec. 83 election No cost to employees Employees have ordinary income er gets deduction