In today's world, companies are striving to tie their employees more closely to the success of the company and to foster their loyalty. One popular method to achieve this goal is to grant employee stock options. This involves employees receiving stock or stock options as part of their compensation. The following blog article addresses just this case, as it can sometimes raise question marks.
Covered are the incentives as well as the tax consequences:
Employee Stock Ownership Plans
Among employee stock options, there are three ways in which employees can have a stake in a company:
Employee stock: in this case, employees receive a block of shares in the company and participate directly in the company's profits. There are two types of employee shares:
Free employee shares, which the employee can freely sell or pledge after receiving them.
Restricted employee shares, which are subject to a lock-up period and may only be sold after this period has expired.
Employee options: Employees are granted the right to purchase shares in the company at a later date at a fixed exercise price. Here, too, a blocking period can be agreed, during which the shares acquired may not be sold.
Vested rights: Through a so-called vesting period, employees have the prospect of acquiring shares after a certain period. The shares are either given free of charge or offered at a preferential price. The vesting period is often linked to the duration of the employment relationship.
Non-genuine employee stock options
There are also so-called non-genuine employee stock options. These include phantom stock and co-investments:
Phantom stock: employees receive a virtual share that reflects the performance of the real share. Although the employee does not own an actual share, he or she participates economically in the performance of the share, but has no right to information or participation.
Co-investments: Management can buy into the company and thus participate directly in the company's profit or loss. However, it is only considered a non-genuine employee participation if the management is not granted comprehensive ownership rights.
Taxation of employee shares
Taxation of employee shares
Non-genuine employee shares are taxed immediately upon issue to the employee. The difference between the transfer value and the fair market value is the basis for taxation. For listed shares, the closing price on the date of purchase is considered the fair value; for unlisted shares, the fair value is calculated by the employer.
Restricted employee shares are also taxed upon surrender. Lock-up periods are taken into account as a value-reducing factor in the tax calculation. A discount of approximately 6% per vesting year is deducted from the market value, reducing taxable income. A vesting period of up to 10 years or approximately 44% is deductible.
When employee stock is sold after the vesting period, a capital gain is tax-free or a loss is not deductible.
Taxation of employee options
Free listed employee options are taxable at the time of issue. The amount of tax is equal to the difference between the fair market value of the share and the lower grant price.
In contrast, restricted or unlisted employee options are taxable only when they are exercised or sold. The amount of tax is then equal to the difference between the exercise price and the fair market value of the share, or the sale proceeds less any transfer price of the employee options.
Taxation of vested rights
Vested awards are not taxed until the vesting period has expired. The difference between the fair value of the shares issued at that time and their issue price is the taxable income.
