Planning for the Payment of Taxes on Private Company Stock Awards (Published by Wall Street Lawyer)
Stock awards are a common and valuable compensation tool for companies to recruit and incentivize key service providers, such as employees, non-employee board members, and independent contractors. Many companies adopt stock incentive programs for these purposes featuring several types of awards, including stock options, restricted stock, and restricted stock units (“RSUs”).
There are many factors to consider when designing and administering a stock incentive program, including the number of shares to reserve, the types of stock awards, exercise or purchase prices, vesting schedules, restrictions on the sale or transfer of shares, repurchase rights, and forfeiture provisions.
In this article, we focus on a critical factor for a successful stock incentive program that is often overlooked — the payment of federal and state income tax and payroll tax (collectively referred to as “tax” or “taxes”) attributed to the stock awards. This critical factor impacts all companies with shares that are not freely tradeable. The tax obligations require either or both the company and the service provider to come up with the funds to pay the taxes due. All too often, the obligation to pay taxes comes as an unwelcomed surprise to both the company and the service provider that can result in the stock incentive program becoming a financial headache rather than a valuable incentive. Even though information about the tax obligations is communicated by the company to the service provider, the tax obligations typically are not fully explained or understood by the service provider.
All stock awards are subject to taxes at some point in time. While a summary of stock award taxation is beyond the scope of this article, it is important to understand when the company and service provider become responsible to pay the taxes due. Generally, taxes are due for stock awards when the fully vested shares underlying the stock awards are issued to the service provider. For non-statutory stock options, the taxable event is at the time of exercise. For restricted stock, the taxable event is either at the time of grant (with a Section 83(b) election) or at the time of vesting. For RSUs, the taxable event is when the shares are issued after the vesting date. The taxable value of the shares is the difference between the fair market value of the shares at the time of the taxable event and the price paid by the service provider to acquire the shares, if any.
The payment of the taxes attributed to the stock awards can be a significant problem for the company and the service provider. Even though the service provider receives the shares, he or she typically may not sell any of the shares to raise the funds needed to pay the taxes due. Notwithstanding that the service provider is unable to sell the shares, the company must collect and remit the taxes due if the service provider is a current or former employee. The company typically is not responsible for collecting and remitting the taxes due for non-employee service providers. While the taxes attributed to the stock awards are ultimately the service provider’s responsibility, the company may face penalties and fines imposed by the IRS if it fails to properly collect and remit the taxes due.
There are multiple alternatives for collecting taxes that the company and service provider should consider. The most common alternatives are the company withholding the taxes from the service provider’s regular payroll or the service provider making an out-of-pocket payment to the company or tax agency. Other alternatives to raise the funds for the tax payments include the company paying a bonus to the service provider, a loan by the company to the service provider, a net-share delivery, or a third-party purchase of shares.
Craig Tanner is a Partner in Rimon’s Employment Law, Employee Benefits and Executive Compensation Practice. He has over 20 years of experience in representing multinational companies with executive compensation, equity compensation, employment, and data privacy matters. In his compensation practice, Mr. Tanner works with his clients in designing and offering, executive compensation and broad-based equity-programs, including restricted stock units, stock options, profit interests, stock purchase rights, restricted stock, phantom stock, and stock appreciation rights, as well as retention, transaction and cash bonus programs. Read more about Craig.
Thomas M. White specializes in the full scope of human resources management, such as Employee Benefits and Executive Compensation, Healthcare, and Employment Law. He began his practice shortly after ERISA was enacted. In this capacity, he has undertaken a full range of contentious, non-contentious and transactional benefits and employment work, and also has extensive experience in the development, documentation and administration of executive compensation programs. He has worked on behalf of clients ranging in size from start-ups to Fortune 500 enterprises. Read more about Thomas.