SPEED ROUND: Stock Compensation

Dark Horse CPA

Need the quick and dirty on stock compensation? Dark Horse CPAs’ Natalie Cohen will lay the foundation of what you need to know in less than 5 minutes.

Podcast Transcript

hello, tax simpletons just made that up on the spot. This is taxes made simple after all, as  you probably noticed, the name of this episode has the phrase speed round in it. The point  of speed round episodes. Is to deliver the need to know aspects of a dense but important tax  topic in five minutes or less, we know that we have a limited amount of your increasingly  shortening attention span to capture. 

So this is going to be quick and painless with me for today’s inaugural speed.  Round on stock compensation is Natalie Cohen who runs a dark horse CPA practice in  Portland, Oregon. And today’s discussion is for employees and employers who want the  quick and dirty on stock compensation. We’re going to release additional speed rounds that  go into further depth. 

On the topics touched on today over the next couple of weeks. Hokey-doke  Natalie. Thanks for being here. Glad to be here. And are you properly caffeinated? I think I  am. Let’s go. Okay. Well, let’s dive in. What is a stock option? A stock option is as the name  implies an option to purchase a certain number of shares at a certain price. 

And what does it mean to exercise an option? To exercise a stock option means  that you paid that certain price to purchase a certain number of shares after exercising the  option. You now own those actual shares. And can you tell me a little bit about what tax  basis is tax spaces is essentially a fancy way of saying what you’ve paid for the shares. 

It can also be the amount that you were taxed on as ordinary income. To the  extent you didn’t actually pay cash for the shares. And what does the term vesting mean? So  you can think of vesting as being synonymous with earning, when your equity in a company  vests, it is generally yours. Oftentimes employers will require equity to vest over a number  of years in order to incentivize you to stay with the company. 

If you leave before any part of the equity vests, you forfeit your right to the  equity and what exactly happens when your equity vests. If it’s an option, generally, nothing.  If it’s for stock, which is usually in the form of restricted stock, you’re a tax on the fair market  value of the stock on the vesting date as if it had been paid to you like normal cash salary or  wages. 

And what is an 83 B election and that’s B as in boring. So an 83 B election is an  election. So it’s optional and requires a filing with the IRS, right? The election is made by  someone who has unvested options or shares that is electing to be taxed on the value of the  equity. Now, before those shares best. 

So why would anyone make an 83 B election? So if the value of the stock is  increasing or you expect it to increase than the amount of tax you’ll pay, if you make the  election now is less than it will be. If you wait until the stock vests also the tax paid, when  you eventually sell the stock will likely be taxed at more preferential tax rates.

And what are the risks of making an 83 B election? So if the stock never vests, you  don’t get to recover the taxes paid. And if the SOC loses value, all you’ll have is a capital loss,  which could take many years to fully utilize against other income. So what types of stock  compensation are most common? 

The different types of stock compensation that I typically see include non qualified stock options, also known as an SOS or non quals. Incentive stock options also  known as ISO’s or ISOs employee stock purchase plans also known as ESP peas, restricted  stock units also known as RSUs and Phantom stock, which can go by a number, different  names. 

Great. So what is N N S L? So an NSO is an option to buy a certain number of  shares at a certain price. When you exercise the option, you have to pay tax on the  difference between the price you paid for the sock and its actual value at the time you  bought. And so what about an ISL? And I suppose like an NSO, except there’s no tax due. 

When you exercise the option. In certain circumstances, you might owe  alternative minimum tax, also known as AMT when you exercise an ISO, but that’s a topic for  a different conversation, I suppose, or tax once the actual shares have been sold and which  is better an ISO or an NSL. Okay. Generally, I would say an ISO, as it matches cash received  with the taxes owed from the sale, since there was no tax owed exercise. 

Also the taxes have a higher likelihood of being long-term capital gains rates,  which are lower than ordinary income tax rates. And what is N E S P P? So an ESP P generally is the option to buy stock at a 15% discount from the current market value. That 15%  discount is tax via payroll. When you purchase the shares, when you sell the sock, you’ll have  either long-term or short-term capital gain, depending on how long you held the stock. 

And what is an RSU? An RSU is essentially stock in the company that becomes  yours as it best it’s taxes, ordinary income. When it vests at the market value at the time of  besties. And what is Phantom stock? So Phantom stock is basically a stock appreciation,  right? Which means the right to participate in the increase in the value of a certain number  of shares. 

The caveat is that you don’t actually own the shares. And oftentimes the rather  rare liquidation of it is required to get paid. When you own Phantom stock, when you do get  paid, it’s in the form of a bonus through payroll, we did it, Natalie, you are a rock star. Few is  right. That’s a lot of information to cover in a short amount of time, but we did it. 

Okay. Well that wraps it up. I think we’re just under maybe a little about the five  minute Mark. So join us for our next speed round where we’ll dive deeper into NSOC and  ISO’s so thank you for tuning into TMS, or if you’re not into the whole brevity thing, taxes  made simple because there’s TMI and then there’s TMS. 

And now for the disclaimer, the content in the proceeding podcast should not in  any way be construed to be tax advice. All tax laws are nuanced in. Those are applied to  each unique situation differently. Don’t be a dummy IRS CPA, preferably a dark horse CPA.

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