HR Support on Rules Around Employee Stock Options

Editor's Note: Final IRS regulations clarify stock transfer conditions.

Rena PirsosOverview: The fair market value of vested, unrestricted stock provided to employees as compensation, less any amount the employees pay for the stock, is subject to federal income (FIT) and FICA (Social Security and Medicare) tax withholding and federal unemployment insurance (FUTA) tax in the first year employees' beneficial interest in the stock may be transferred. The same rule applies to stock that is subject to a restriction that will never lapse. The fair market value of stock, less any amount employees pay for the stock, that is subject to a substantial risk of forfeiture is subject to FIT and FICA tax withholding and FUTA tax when the restriction lapses.

A stock option is a right or privilege extended to employees to buy company stock at the price described in the option. Employees do this by exercising their options. In general, employees do not have taxable income when they receive options.

Qualified stock options - incentive stock options (ISOs) and stock purchased through employee stock purchase plans (ESPPs) - are subject to favorable tax rules; non-statutory options (NSOs) do not have favorable tax rules. Options that were granted as ISOs and ESPPs, but that fail to qualify as ISOs or ESPPs, are treated as NSOs.

The IRS issued final regulations under Internal Revenue Code § 83 clarifying when "a substantial risk of forfeiture" exists when property (e.g., stock) is transferred in connection with the performance of services by an employee.

Author: Rena Pirsos, JD, Legal Editor

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