Probate & Trust Law Section Conference Manual ... - Minnesota CLE

The Well-Prepared Executive: Personal Wealth Preservation Strategies
I. INTRODUCTION
In today’s competitive job market, companies
usually find that hiring and retaining qualified
executives requires some type of equity
compensation plan. Valuable employees fully
expect to share in the future appreciation in the
value of the company.
Equity compensation plans can be broadly
divided into three categories: (1) actual equity
ownership, such as restricted stock plans; (2)
potential equity ownership plans, such as stock
options; and (3) those plans which do not result in
actual or potential equity ownership but give a
contractual right to a cash payment based on
appreciation in the company’s value, such as stock
appreciation rights. Each of these equity
compensation plans aligns the executive’s interest
with the interest of the shareholders by rewarding
the executive for increases in stock value. Most
plans are subject to vesting provisions that are tied
to continued employment, company performance
goals, or more specific performance goals tailored to
the individual executive or the executive’s division.
This outline focuses on basictax considerations
related to equity compensation plans. With the
current spread between the 20% long-term capital
gains rate and the 39.6% ordinary income tax rate,
and the 40% top marginal gift tax and estate tax
rate, the executive’s tax considerations have become
particularly important. An executive typically has
three tax goals: (1) minimize taxes owed upon grant
of the equity compensation; (2) minimize
“phantom” income (i.e., taxable income without
cash); and (3) maximize capital gains.
More particularly, this outline focuses on basic
tax considerations associated with common forms of
equity compensation for executives, including (1)
restricted stock plans, (2) incentive stock options,
(3) non-qualified stock options, (4) stock
appreciation rights, (5) employee stock purchase
program, (6) distributions of company stock from a
qualified plan, and (7) basic SEC considerations
related to insiders.
II.
RESTRICTED STOCK PLANS
A. Description
A restricted stock award is the grant of
stock or sale of stock at market value or
discounted value to the executive, subject to a
vesting schedule. Unvested shares typically are
subject to forfeiture or resale to the company at
the original purchase price upon the executive’s
termination of employment or resignation.
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B. Executive ’s Income Tax Consequences
1. Grant The executive recognizes no
income tax upon receipt of unvested restricted
stock, unless the executive make the Internal
Revenue Code (“IRC”) § 83(b) election as
discussed below. IRC § 83(a).
a. Purchase of Unvested Stock for Fair
Market
Value
IRC § 83 applies to a transfer of
property “in connection with the performance
of services.” If an executive purchases stock at
fair market value that is subject to a “substantial
risk of forfeiture” (i.e., vesting), the stock is
subject to IRC § 83 even though the executive
paid fair market value. Alves v. Commissioner,
79 T.C. 864 (1982), aff’d., 734 F.2d 478 (9 th
Cir. 1984).
2. Disposition Prior to Vesting
An arm’s-length disposition of restricted
stock will trigger compensation income to the
executive equal to the value of the stock as of the
date of the disposition less any amount paid for the
stock. Treas. Reg. § 1.83-1(b)(1). A non-arm’slength
disposition such as a gift or contribution to a
related entity does not close the compensation
element and the executive is still subject to income
tax when the stock becomes vested even though the
executive no longer owns the stock. Treas. Reg. §
1.83-1(c).
3. Vesting
The executive recognizes compensation
income (i.e., ordinary income) when restricted stock
is transferable or no longer subject to substantial
risk of forfeiture (i.e., upon vesting). IRC § 83(a).
The amount of income recognized at the time of
vesting equals the difference between fair market
value of the stock at that time less any amount paid
for the stock. IRC § 83(a). The executive’s holding
period begins at the time of vesting for purposes of
the one-year requirement for long-term capital gains
and the five-year requirement for the 50% exclusion
under Section 1202. IRC § 83(f).
a. Stock Restrictions are Ignored in
Determining
Value
For purposes of determining fair market
value, restrictions on the stock such as securities
law, lock-up, and similar restrictions are ignored.
IRC § 83(a). For example, assume at the time of
vesting that the stock is trading at $20 per share but