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Are restrictions placed upon the stock in the employment contracts, stock plans or other documents? There are many types of restrictions, but one example would be a restriction on the sale or transfer of the stock by the employee. If the corporation were liquidated, does the employee or independent contractor have a right to a liquidation distribution? For example, if a service provider i. If the stock declines in value, the service provider can decide not to pay the note and forfeit the stock.

In these circumstances, the service provider has not incurred the risk of a beneficial owner if the value of the property declines substantially. Determine if there was transfer of stock options to a related person. Determine whether there has been a reduction in the purchase price of a note used to acquire employer stock.

Under Treas. See Rev. The election must be made no later than 30 days from the date the property is transferred to the service provider, with no extensions. See Revenue Procedure Rev. Determine whether a substantial risk of forfeiture exists depends on the facts and circumstances. Generally, a substantial risk of forfeiture exists only if rights in property that are transferred are conditioned, directly or indirectly, upon the future performance or refraining from performance of substantial services by any person, or upon the occurrence of a condition related to a purpose of the transfer.

Property is not considered transferred if it is subject to a substantial risk of forfeiture, and at the time of transfer, the facts and circumstances demonstrate that the forfeiture condition is unlikely to be enforced.

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See Treas. Individual s that qualify as an executive under the section 16 b of the Securities Exchange Act of could be subject to suit if sold the stock at a profit within six months after the purchase of the stock. Lapse Restrictions are restrictions other than non-lapse restrictions see below and include restrictions that carry a substantial risk of forfeiture. Non-Lapse Restrictions will never lapse and requires the holder of the stock to sell, or offer to sell, the stock at a price determined under a formula.

They are not considered substantial risks of forfeiture and never postpone the recognition of income, therefore, the service provider recognizes income immediately upon grant and the company is allowed a deduction.

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A Non-Lapse Restriction is not dependent upon the service provider performing services for a specified number of years. Rather, the restriction will terminate upon the occurrence of a specific event such as a change in control, termination of employment, or death of the service provider. A common Non-Lapse Restriction generally with a non-public employer is when an employer requires the employee to sell the stock back to the employer at book value whenever the employee wishes to dispose of it for any reason. In this case, book value will be considered FMV when determining the amount included as compensation in the service provider's gross income.

The employee will recognize as compensation the difference between book value and any amount paid for the stock. Dividends from restricted stock. If an employee or independent contractor receives dividends or other income from substantially non-vested restricted stock, the amounts are considered additional compensation to the individual and must be included in income, are subject to employment taxes, and may be deductible by the corporation.

Incentive Stock Options (ISOs)

Once the restricted stock award vests, the dividends are treated as dividend income rather than compensation. In order to determine if there is an issue with stock options, the examiner must determine the type of stock option received by the individual. The exercise of Statutory Options does not result in income compensation or income tax to the employee, and the employer may not take a compensation deduction. See Notice , C.

For information regarding employment taxes, see Notice The examiner should review the terms of a Statutory Option and verify that it is not allowable for it to be treated any other way than as a Statutory Stock Option. A qualifying disposition occurs when the employee holds the stock for at least two years from the date of grant and one year from the date of exercise. If the specific holding period requirements are met, then the employee recognizes capital gain or loss on disposition of the stock but there is still no deduction for the employer.

The excess of the FMV of the share on the date of its disposition over the amount paid for the share, or. If the option price is not fixed and determinable at the time the option is granted, the option price will be computed as if the option had been exercised on the grant date. See Notice Any additional gain on the disposition of the stock is characterized as capital gain.

The employer receives no tax deduction for the compensation recognized by the employee under this special rule. A failure to meet the holding period requirements results in a disqualifying disposition of the stock purchased by exercising a Statutory Stock Option.



In that event, the employee has compensation ordinary income on the date of the disqualifying disposition equal to the difference between the exercise price and FMV of the underlying stock on the date of exercise. If the stock at issue was restricted i. In the event of a disqualifying disposition, the employer is entitled to a corresponding wage deduction.

Stock Options

Pursuant to Treas. This limit is determined based on the FMV of the stock at the time the option is granted and not at the time the option vests. At the time of exercise, this results in ordinary income to the employee and a wage deduction to the employer. The transfer of stock to the employee pursuant to the exercise of an ISO after December 31, shall be reported on Form With respect to the exercise of an option under an ESPP after December 31, , the transfer of stock to the employee is reported on Form Non-Statutory Stock Options generally result in ordinary income and wages on the date of exercise or other disposition Rev.

Special rules apply to an option with a readily ascertainable FMV. Generally, the company can provide a Non-Statutory Stock Option report which should show, by employee, the option grant date, exercise date, employment taxes withheld and the type of information return furnished. Extra steps must be taken to reconcile deductions to the proper year for companies with a fiscal year end.

Discrepancies in the reconciliations may indicate an income or employment tax issue. If the options are offered to directors, ascertain whether a Form was issued. Schedule C or on line 21, Other Income , along with self-employment tax upon exercise or other disposition. Depending on the terms of the arrangement, the employee may be entitled to receive only the growth in the value of the stock between the time the employer awards the phantom shares and the time the employee cashes out the shares.

Alternatively, the employee may be entitled to receive the entire value of the stock as well as any dividends paid from the time the employer grants the phantom shares. The employer does not hold actual shares of stock for the employee, but depending on the terms of the plan, the employee may be paid in actual shares or in cash at the time of the cash-out. The examiner should determine if the company engages in such practices and if so obtain an understanding of the terms of the arrangement.

However, such appreciation is income to the employee and subject to FITW. Stock Appreciation Rights are another method of compensating employees or independent contractors. The employee can only benefit from the appreciation in the value of the stock; therefore, a taxable event does not take place until the exercise of a SAR. However, if the terms of the SAR limit the amount that an employee may receive upon exercise, the IRS has ruled income has been constructively received in the tax year in which the maximum limit has been attained.

Businesses can acquire needed services without dipping into their coffers, and contractors can make an investment with minimal cash and potentially realize significant returns. A barter exchange is simple, right? No so fast! Lawyers with clients who own or provide services to tech startups should know that there are many considerations for both the business and contractor that are often overlooked when structuring equity-based compensation plans.

In fact, participation in such plans can have unforeseen tax consequences. Equity plans such as stock options are designed to incentivize employees.

NSO or Non Qualified Stock Option Taxation | Eqvista

In Canada, when an employee is granted stock options, there are no tax consequences until the option is exercised. Also, under the right circumstances i. The Income Tax Act provisions that address the favourable tax treatment apply to employees, not independent contractors.

Independent contractors must recognize the value of the option as business income that is per cent taxable when the option is granted. This means the tax cannot be deferred to the time when the options are exercised. Furthermore, the preferable 50 per cent security option deduction also applies to employees only. Stock options held by independent contractors that have increased in value since grant must recognize the growth from the date of grant as regular income at vest. Adding insult to injury, the income recognized as business income at grant and vest is also subject to HST. Applicable sales tax varies by province.

Another issue is establishing fair market value. In the case of options being granted to an independent contractor, both parties must agree on the value of the underlying stock and the value of the goods or services rendered. The issue for contractors is that fair market value of startups is no exact science. However, this is the value that will be subject to income and sales taxes.

Independent contractors are, in general, a highly mobile workforce. This is especially true between Canada and the U. Unfortunately, when it comes to equity compensation for contractors, tax complexities are increased when the option holder works in multiple countries.

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A common U. For example, stock options granted with an exercise price less than the fair market value of the underlying stock at the time of grant are subject to A treatment in the U. The company must complete a A valuation — a formal report that sets the current value of a company's stock and the price to purchase that stock — to ensure the option does not result in punitive taxation. In Canada, equity incentives such as restricted stock awards RSAs , restricted stock units RSUs , stock appreciation rights SARs and phantom stock plans may be subject to salary deferral rules.

For example, an RSA would fall into this category if the vesting period exceeds three years. This means that the income must be taxed on a current basis regardless of when the income is actually paid, effectively negating the tax deferral.