Rewarding Employees with Stock - Employee Benefits Law Group (2024)

As an employer, you’ve developed a remarkable team that has significantly contributed to your company’s growth. You want to reward their hard work by offering them a share in your success. It’s important to approach this with careful consideration to avoid any unforeseen tax or corporate governance issues.

Equity Readiness Survey

First, evaluate the significance of stock ownership to your employees and the potential impact of implementing a broad-based plan. The Equity Readiness Survey from the National Center for Employee Ownership (NCEO) is an excellent resource for this purpose. The survey analyzes key factors and employee motivations, such as the company’s culture, current employee sentiment toward the company and their roles, and whether the board’s selection and design may align employees with the company, thereby enhancing their engagement and satisfaction.

After this review, if you decide to proceed with an equity compensation plan for employees, here are three common scenarios where employers may face challenges.

Granting or Selling Stock to Employees at a Discount

The IRS views transfer of stock to an employee as taxable, even if it’s intended as a gift. If an employee receives stock without paying market price or if it isn’t excluded from income as a fringe or other benefit, the employee will be subject to income tax on its value and the employer will pay payroll tax. This reduces the overall benefit of the stock transfer for both parties, potentially leading to unexpected taxable income for the employee without the liquidity to cover it.

The same tax implications apply when selling stock to an employee at a discount with the exception of an employee stock purchase plan (ESPP). The employee incurs taxable income and the employer owes payroll tax on the difference between the stock’s market value and the price paid by the employee. From a tax perspective, this option is inefficient.

Providing Stock with No Exit Strategy

Planning for potential changes in the employee-employer relationship is necessary even if it seems unlikely. In the event of a dispute or separation, having a predefined exit strategy is important. A shareholder agreement outlines the conditions, timing, and pricing for repurchasing an employee’s stock. For example, if an employee leaves on good terms, they may be required to sell their stock back to the company or other shareholders at a predetermined price within 90 days. In cases of termination for cause, the stock can be repurchased at a discount. This foresight helps ensure smooth transitions and protects the company’s interests.

Offering Stock When Alternatives May Suffice

What if you can accomplish the goals of transferring stock to an employee without having to transfer actual stock? Many employers opt for “synthetic equity” as an alternative. Synthetic equity is a grant of units that are treated like shares of stock, but do not come with shareholder rights. Depending on the plan’s structure, the employee can cash in their synthetic equity units at a predetermined time or event, receiving either the current stock value or the difference between the grant value and the cash-in value. A well-designed synthetic equity plan can defer taxes until the employee cashes in, aligning their interests with the company’s without complicating governance.

There are many ways to transfer actual stock or the value of stock to your employees. From stock option plans and employee stock ownership plans (ESOPs) to restricted stock and stock appreciation rights plans (SARs), there is likely a plan design that gives your valued employees the benefits of ownership without incurring unexpected taxes or governance issues. We can guide you to the plan design that helps you retain and recruit valued employees. Let’s start a conversation.

Updated June 3, 2024