Alternative Compensation Packages
Corporations increasingly are offering new compensation incentive packages for employees as a way of offsetting a corporate culture where raises are becoming fewer and farther between. One type of such new incentives is broad based: "stock options" or "success shares."
The increasing popularity of this incentive option can be linked to two factors. First, the Financial Accounting Standards Board (FASB) has determined that corporations do not have to take a charge against earnings for fixed term options. Additionally, employers see offering stock options to all employees, rather than simply to senior -level management, as a way of getting all employees to "think like owners" rather than employees.
Employers should be wary that employees often are naive; many do not understand the risks associated with stock option investments. Therefore, employers should educate their employees prior to issuing any stock options, and inform each employee that they should seek appropriate legal, tax and/or financial planning counsel before exercising any stock options.
There are several different stock option plans that corporations can offer in a broad-based grant to all employees.
Incentive Stock Options
The first type is an incentive stock option (ISO). There are several limitations to an ISO. An ISO is limited to employees only. In addition, each employee who is granted an option is limited to an amount that is not greater than $100,000 in a calendar year. The value of such options is determined at the time an option is granted. The employee recognizes no income upon the grant of an ISO and incurs no tax upon the exercise of an ISO unless the optionee is subject to the alternative minimum tax. Tax treatment of ISOs is also contingent upon the amount of time that an optionee holds the ISO before exercising the option.
Non-Qualified Stock Options
Another type of stock offering is a Non-Qualified Stock Option (NQSO). NQSOs can be granted to persons who are not employees of a corporation (i.e., board or director member, consultants, etc.). No taxable income is recognized at the time an NQSO is granted. However, upon exercise of an NQSO, the person will be deemed to have earned compensation in an amount equal to the difference between fair market value of the shares on the date the option is exercised and the purchase price. That amount must be treated as ordinary income by the optionee and may be subject to income withholding by the corporation. It is important to note that a corporation is not limited to a plan that provides only ISOs or NQSOs, corporations can offer a plan that includes both incentive plans.
Phantom Stock Options
Another non-monetary form of incentive compensation is a Phantom Stock Plan. This plan offers several positive features. The corporation can take a deduction for the value of such shares at the time the employee receives same.
In addition, payments should constitute earned income in the case of employees who might have an alternative minimum tax concern. Lastly, the corporation is free to select which employer/employees will be included in the plan and different terms may be selected for different types of employees. These types of plans have no anti-discrimination, top-heavy, annual dollar limitations or similar restrictions.
Interested corporations should consult with their legal counsel to determine which type of plan, or combination thereof, is best suited for their needs.