Taxation of Employee and Consultant Equity Compensation

Authored by Bryan Springmeyer Bryan Springmeyer is a California corporate attorney who represents startup companies. The information on this page should not be construed as legal advice.

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	Incentive Stock Option (ISO)	Nonqualified Stock Option (NSO)	Restricted Stock
General Description	Meets the definition provided in Internal Revenue Code §422. Provisions include: employee recipient, exercise price equal to or greater than fair market value ("FMV") of the stock at the time of the grant, timing restrictions.	Also referred to as nonstatutory stock option: An option that does not meet the definition of ISO provided in IRC §422.	Common stock for which the company has a right of repurchase based on vesting conditions being met.
How is the Employee Taxed?	Grant: No taxable event Exercise: No taxable event, but the difference between the exercise price and the FMV at exercise ("spread") goes into Alternative Minimum Tax calculation. Sale of Stock: If the statutory holding requirements are met (stock sold at more than two years after grant and more than one year after exercise) long-term capital gains rate applies.	Grant: Generally no taxable event. However, if options are granted with below FMV exercise prices and become vested, IRC §409A (and possibly state deferred compensation taxes) will apply. Valuations must be made in compliance with 409A. Exercise: Spread taxed as income. Sale of Stock: Sale price minus tax basis (exercise price + spread) taxed as capital gain or loss. If stock is held for longer than one year, long-term capital gains rate applies.	Issuance:If no 83(b) election is made, the difference between FMV of the fully vested stock and the purchase price paid. If 83(b) election is made, difference between FMV and purchase price of all stock, vested and unvested. Sale of Stock: Difference between sale price and tax basis (purchase price) taxed as capital gain or loss. If stock is held for longer than one year, long-term capital gains rate applies.
How is the Consultant Taxed?	Not applicable. Only employees may receive ISOs.	Grant: Generally no taxable event. However, if the company has a readily determinable value (see IRS Publication 525) and that FMV is greater than the exercise price, the difference will be taxed as income. 409A will not apply to bona fide consultants (actively engaged in providing services and < 70% of revenue comes from any one company or group of companies). Exercise: Spread taxed as income. Sale of Stock: Sale price minus tax basis (exercise price + spread) taxed as capital gain or loss. If stock is held for longer than one year, long-term capital gains rate applies.	Issuance:If no 83(b) election is made, the difference between FMV of the fully vested stock and the purchase price paid. If 83(b) election is made, difference between FMV and purchase price of all stock, vested and unvested. Sale of Stock: Difference between sale price and purchase price taxed as capital gain or loss. If stock is held for longer than one year, long-term capital gains rate applies.
Be on the lookout for:	Alternative Minimum Tax	IRC §409A	IRC §83

 

 

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