Over 20 years ago, the most significant component making up executive compensation was money, which was presented in the form of bonuses and salary. At this point, stock options and stock grants were a mere footnote. However, times have completely changed and stock grants and stock options are more frequently used than money when it comes to employee retention and executive compensation. Due to this, incentive stock options are invaluable to a business.
Nonetheless, many individuals remain unaware of stock grants and stock options, which means that these incentive stock options can't be taken full advantage of in a company. This guide is designed to offer readers insight into the value of the stock grant and stock option in motivating employee retention. Continue reading to find out everything there is to know about employee stock and the long-term benefits of using these stock options. It may also help to understand how old you have to be to invest in stocks before reading further. If at the end you still have questions regarding stock grants, contact a licensed financial advisor to learn more.
What is a Stock Grant?
Stock grants are equipped to keep a company's employees working for a specific set period. A stock grant is also known as an employee grant. An example of this would be a company granting a new employee 50 shares of shock that are vested over a period of two years. This entails that the employee is going to gain this stock only once these two years of working at the company are completed. The employee is going to lose this stock in the business if they leave before this period of two years is over. Due to this design of a stock grant, it works as a robust motivator in employee retention.
What are Stock Options?
Stock options function by a company granting its various workers a specific number of stock options, which are set at a time limit and a certain price. From here, the employee can buy this set number of stocks at the price chosen by the company within a pre-determined timeframe. Typically speaking, the amount these employees purchase the stock options for is lower than the current market value. Due to this, the employee is given a bonus in the form of the difference between what they bought these stock options for and the market value of this stock.
What is the Difference Between Stock Options and Stock Grants?
Stock grants and stock options might sound similar in nature, but there are prevalent differences in the advantages between these two stock types.
Advantages of a Stock Grant:
Stock grants are designed with the benefit of being equitable property. Due to this, these stock grants have some intrinsic value. When the stock market is classified as being volatile, stock options are known to become less valuable than a company's employee cost. This makes stock options seemingly worthless. With that being said, stock grants are equipped to constantly remain at some value, as the employees of a business haven't outright purchased these stocks.
In addition to this, some employees aren't informed that they need to take action to receive this stock when being provided with stock option incentives. Due to this, employees commonly fail to exercise this opportunity and receive the stock options. The design of stock grants removes this mishap from occurring by outright granting the stock to the employee.
Advantages of Stock Options:
Stock options are equipped to provide greater value to the employees that gain such stocks. An example of this if an employee gains the option of purchasing a stock at $7 for each share and the value of the stock increases rapidly. The employee can buy more stock at the option price, which increases their profit on the stock.
Adding to this, stock options are more flexible than stock grants. This is because these options are equipped with an early exercise option. Due to this, an employee can exercise his options if they are intended on leaving the company. This can be done even before the end of the vesting period. Thus, the employee can gain the benefits offered by the shares of stock without having to remain working for the company.
What Types of Stock Options Do You Get?
There are two types of stock options available for companies to grant. These are incentive stock options (or ISOs) and non-qualified stock options (or NQSOs). From these two options: the incentive stock options provide significant tax benefits, but are also constructed in a way that raises the risk associated with the alternative minimum tax, or AMT.
Non-Qualified Stock Options
Non-qualified stock options are one type of stock option that doesn't feature any favorable tax treatment when dealt with under the US Internal Revenue Code. As a result of this, the use of the word, 'non-qualified' applies to the tax treatment of these stocks because it isn't eligible for special tax treatment or any other favorable considerations.
With that being said, NQSOs are the most common type of stock options and are typically granted to consultants, contractors, directors, officers, and employees.
Incentive Stock Options
Incentive stock options, or ISOs, are designed in a way that qualifies these stock options for special tax treatment when placed under the US Internal Revenue Code. In addition to this, these ISOs aren't subjected to Medicare, Social Security, or withholding taxes. Nonetheless, to qualify for these taxation treatments, these stock options are required to meet rigid criteria under the US tax code. In addition to this, the mechanisms making up incentive stock options detail that these can only be granted to employees. Such stock options can't be released to contractors or consultants, which is unlike NQSOs.
Employee Stock Compensation and Vesting
When a company provides an employee stock as part of its compensation, this stock is typically restricted. As the use of 'restricted' entails, any restricted stock has certain restrictions on how the employee and future owner of this stock may use it. Generally speaking, an employee of a company is required to hold onto this restricted stock for a specific time.
This period is defined by the company related to the issuing of the stock. During this time, employees aren't allowed to dispose of this stock for a reward in any way. This includes selling it. In addition to this, many companies also provide stock grants, which form part of the employee compensation plan for the company. When such stocks are presented in the company's compensation plan, these generally carry various restrictions outlined by the company, which detail when such stocks can be exercised by the employee.
When looking at the element of vesting in terms of employee stock, an employee doesn't have the right to do anything with a stock even if this employee has earned the stock as part of their compensation. The employee only has this right once the stock has been vested.
Vest rights over a stock are absolute. Due to this, an employee has the right to take legal action if these vested rights are damaged or withheld. These employee stock rights are vested when the employee has the right to transfer the shares of stock without any limitations or restrictions. Otherwise, an employee is also given this vested right when the employee can leave their employment when the period of time dictated in the stock's terms is reached.
The Vesting Period
Stock grants are typically accompanied by a 'vesting period' when a company offers a stock grant to a worker. During this outlined period of time, this specific employee award the financial compensation in the form of stock grants is prohibited from selling these stock grants. In addition to this, the stock doesn't vest until this period is over. The employee also loses some of all of their rights to these stock grants if they leave before this vesting period is over. Nonetheless, once this time is over and the stock grants are vest, the employee can do whatever they want with these stock grants. This is unless the terms of these stock grants place permanent limitations and rules, which need to be upheld by the owner.
How Does a Stock Option Grant Work?
These options provide employees with the opportunity to purchase shares of a company at a specific price, which is lower than the market price per share. Employees who take up this opportunity and purchase these shares at a cost lower than the market price and sell these when the stock of a company when it's trading significantly higher can make a lot of money. This is because these employees can sell the stock when the stock price is higher. Thus, offering long and short-term capital gain.
Frequently Asked Questions
What are employee stock options?
These options are a type of equity compensation that's granted by companies and given to executives and employees. This provides employees with the opportunity to purchase stocks from these companies at a lower price than the market value. This offer is only valid until a finite date and is a compensation reward given by a business to increase employee motivation.
What does accepting a stock grant mean?
The rules behind stock grants indicate that it's equity compensation, which is free. The employee isn't obligated to purchase this stock to accept it. An employee isn't required to pay for this stock when they accept it, as this is 'gifted' by the business. Due to this, employees aren't making any financial agreement when they accept this stock. Instead, they generally accept the offer to pay for these shares of stock at a future point in time.
Why do companies grant stock options?
A business might offer equity compensation to employees in the form of options as a way to motivate employees. This is a type of investment, which allows the legal holder of the stock to purchase a specific number of shares of the business's stock at a lower price. Employees can accept this offer and hold onto the options until these are vest. After this, the employee can get paid for transferring the ownership of these shares. From doing this, they receive gains related to the sale. Companies partake in this financial investment as a method to increase employee retention.
What is restricted stock?
An example of this is unregistered shares of ownership, which are present in a corporation and issued to corporate affiliates. These include directors and executives. These are typically an investment that's non-transferable and needs to be traded in compliance with unique regulations related to Securities and Exchange Commission (or SEC).
Are stock grants considered earned income?
When it comes to RSUs, employees are taxed on these financial investments once these awards are delivered. This means that these stocks are typically taxed once the vest period is over. The taxes paid for this stock are equivalent to the market value per share at the time these stocks are recognized as being vest. Due to this, stocks are seen as taxable income. Employees with these stocks have compensation income, which is subject to employment (Medicare and Social Security) and federal tax, along with any other local and state taxes associated with such investment. This is considered different than accessible income. Alternatively, exercising options that people pay for on the market are handled differently. Any profits that are earned from these options are recognized as capital gains. This entails that the profits gained from these options are seen as being received as compensation for working. Thus, this capital gain doesn't affect the taxable amount from an individual Social Security benefits.
How are stock grants taxed?
Employees have two options if they're granted a restricted stock offer. They can either pay the ordinary income tax on this award when the stock is vest and be taxed on the long-term capital gain when they sell. Otherwise, the employee can be taxed on the entire ordinary income tax amount on the whole investment when it's vest.
Why do companies offer restricted stock?
These restricted stock units are given as part of a business's compensation package, which is used to attract and retain essential employees. These are restricted because certain requirements need to be met. This is before the employee can fully obtain its ownership rights to the value of these units.
Disclosures:
Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Stratos Wealth Partners, LTD., a registered investment advisor. Stratos Wealth Partners, LRD. The Kelley Financial Group, LLC are separate entities from LPL Financial.
This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. The content is developed from sources believed to be providing accurate information.
No investment strategy assures a profit or protects against loss.
