Rewarding Employees with Company Stock
by BarbaraWeltman, Guest Blogger
- Created: September 26, 2013, 11:40 am
If your business is incorporated and you want to reward employees, consider issuing stock. Using this form of compensation has benefits to employees and to you.
If you pay a cash bonus or give a fringe benefit, it’s a cash drain to the company. Issuing stock as compensation is not. You merely issue shares to the employee equal to the bonus, reward, or compensation you intend.
Company stock can come with restrictions on stock transfers or substantial risk of forfeiture that effectively tie employees to you. For example, there may be a time frame (say five years) before the risk of forfeiture expires and the employee is fully “vested” in the shares so that he or she can sell them at that time. With a closely-held business, other restrictions may continue, such as a requirement to first offer the shares to the corporation before selling them to an outsider.
For most fringe benefit plans, strict nondiscrimination rules apply to prevent you from selectively rewarding employees. This does not apply to giving stock to employees; you can choose who to reward and how much the reward will be.
This form of compensation is subject to payroll taxes. This means you must pay the employer share of FICA as well as FUTA taxes on the value of the shares issued to an employee.
Giving stock to employees is likely to raise their company loyalty. As a stockholder, they have skin in the game and should want more than ever to see the company succeed.
Stock issued to employees is a form of compensation that’s taxable to them. When and how they are taxed depends on certain factors. If the stock is restricted or subject to substantial risk of forfeiture, there is no immediate tax required. Tax results when there is no longer any substantial risk of forfeiture or the shares are freely transferable. At that time, the value of the shares is taxed as ordinary income. It’s up to the company to set the value.
However, the employee can make a Sec. 83(b) election to report the compensation now, which allows all future appreciation to be taxed as capital gains rather than as ordinary income. The election must be made no later than 30 days after the date that the stock is transferred to the employee by filing it in the IRS service center (it’s not filed with the employee’s tax return but should be attached to the return). The IRS has a sample election that you can give employees to use for making an election. There is a risk in making this election. The employee cannot recoup any income tax paid when the stock is received if he or she leaves the company before shares have vested so that the shares are lost to this employee; no loss is allowed.
If you issue qualified small business stock before January 1, 2014, and the employee holds it for more than five years, all capital gain becomes tax free. After this year, the exclusion for qualified small business stock declines from 100% to 50% unless Congress extends the current break. Qualified small business stock has specific limitations: the industry you’re in, being a C corporation (not an S corporation), having assets of $50 million or less, and more. Find more details about qualified small business stock in IRS Publication 550.
Before you issue stock as compensation to employees, consider carefully what this means to the dilution of your ownership interests. Work closely with an attorney to craft a stock plan that works for your situation.
About the Author
Barbara Weltman is an attorney, prolific author with such titles as J.K. Lasser's Small Business Taxes, J.K. Lasser's Guide to Self-Employment, and Smooth Failing as well as a trusted professional advocate for small businesses and entrepreneurs. She is also the publisher of Idea of the Day® and monthly e-newsletter Big Ideas for Small Business® and host of Build Your Business Radio. She has been included in the List of 100 Small Business Influencers for three years in a row. Follow her on Twitter: @BarbaraWeltman.
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