Using stock-based compensation plans.

• Author: King, Jared W.

Stock-based compensation plans offer an excellent way for companies to reward key executives with tax-deferred compensation without running afoul of the nondiscrimination rules associated with retirement plans. They are particularly well-suited for fast-growing companies whose stock prices are increasing rapidly. By using stock-based compensation, cash-poor companies with lots of potential can attract and retain key employees through the promise of company stock or stock options.

There are many different types of stock-based compensation plans, e.g., nonqualified stock options, incentive stock options (ISOs), restricted stock grants, stock appreciation rights (SARs) or performance share plans. From a tax perspective, the two best plans are ISO plans and restricted stock plans.

ISO plans are plans specifically qualified under the Internal Revenue Code that grant eligible employees options permitting them to purchase company stock at a stated price within a set amount of time. So long as these plans meet certain requirements, the employees granted options under these plans may defer taxes paid on the income associated with the purchase of any optioned stock until the date any stock purchased under the plan is sold and, when the stock is sold, may treat any gain in the value of the stock purchased as a long-term capital gain, if the stock has not been sold within two years after the stock options were granted. In order to receive this favorable treatment, the ISO plan must receive shareholder approval within one year before or after the corporation adopts the plan; provide that the options issued under the plan be granted within 10 years of the earlier of...