Marcum 2021 Year-End Tax Guide

Equity-Based Compensation

Provided that the employee sells shares after the ISO holding period requirements have been met, the employee will recognize long-term capital gains, taxed at preferential rates. To receive this favorable tax treatment, ISOs and ESPPs must be held the later of two years after grant date and one year after exercise. For regular tax purposes, the tax basis in the stock is equal to the exercise price. For AMT purposes, the tax basis is increased by the income recognized upon exercise. Disqualifying Dispositions The disposition of a share of stock acquired by the exercise of an ISO before the applicable holding period expires is a disqualifying disposition to which statutory stock option treatment, described above, does not apply. If there is a disqualifying disposition, Section 83 applies, and any income of the employee attributable to the disqualifying disposition is includible as compensation income received in the employee’s tax year in which the disqualifying disposition occurs and is taxed at higher ordinary rates. No amount is treated as compensation income for any other tax year. The income attributable to the transfer is determined in accordance with the rules of Section 83(a), with no reduction for brokerage fees or other costs paid in connection with the disposition. This means that in the tax year in which the disqualifying disposition occurs, the individual must recognize compensation income equal to the stock’s fair market value at the time of exercise, less the exercise price. This compensation income will be added to the ISO stock’s basis for determining the gain or loss on the sale or disposition of the ISO stock, thus making the stock basis equal to the fair market value at the time of exercise. This gain or loss is treated as short-term or long-term capital if applicable holding periods have been satisfied. of employment. This term is extended to one year for disability, with no time limit in the case of death. If the ISO is not exercised within three months of termination, the option is no longer an ISO and will be taxed as a NQSO. As a result, many companies will typically provide for a 90-day post-termination exercise period. This rule may have an impact to the corporation’s deferred tax asset for stock- based compensation. Other Considerations ISOs must be exercised within three months of termination

Equity-based compensation includes any compensation paid to an employee, director, or independent contractor that is based on the value of specified stock (generally, the stock or equity of the employer, which may be a corporation or a partnership). Examples of equity-based compensation include stock transfers, stock options, restricted stock awards, restricted stock units, stock appreciation rights, stock warrants, phantom stock plans, and other awards whose value is based on the value of specified stock. This article discusses the more common equity-based compensation awards: incentive stock options (ISOs), employee stock purchase plans (ESPPs), non-statutory (nonqualified) stock options (NQSOs), restricted stock awards (RSAs) and restricted stock units (RSUs). DEDUCTING COMPENSATORY STOCK- BASED COMPENSATION A compensation deduction is allowed to an employer corporation for compensation paid to an employee or independent contractor through the grant of a stock option or issuance of other equity-based compensation. The amount and timing of the deduction are determined under Internal Revenue Code (IRC) Section 83 rules for compensation paid in the form of property. Under the rules of Section 83, an employer corporation can deduct an amount equal to the amount includible in the gross income of the person who performed the services for the employer’s tax year, which includes the end of the tax year in which the person performing the services must include in gross income the compensation received. If the corporation transferring the property issues the appropriate forms to report the transaction to both the IRS and the recipient, properly completed, the recipient is deemed to have reported the income. TAX IMPLICATIONS FOR ISOS AND ESPPS ISOs and ESPPs may be granted to employees only. Generally, the employer corporation does not receive a tax deduction at grant, exercise or sale. The employee will not recognize ordinary income at grant or exercise. However, in the year of exercise, the excess of the fair market value of the option over the exercise price is income to the employee for alternative minimum tax (AMT) purposes.

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