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

The Well-Prepared Executive: Personal Wealth Preservation Strategies
c. Can be issued by wide range of business
entities (not just corporations).
d. Can be issued to non-employees (such as
directors and consultants).
6.
Summary of NQO Disadvantages
a. Executive has tax liability at ordinary rates
at time of exercise. This can result in significant tax
liability if stock has appreciated in value since the
time the NQO was granted.
b. The IRC § 83(b) election is not available for
NQOs.
1. Useful in closely-held company where
management does not want to give actual or
potential equity ownership in the company to
executives and wants to avoid minority shareholder
issues.
2. Permits executive to realize the appreciation
inherent in stock without payment of the option
price upon exercise.
3. SARs are often issued in conjunction with
NQOs in order to alleviate executive’s cash flow
problems at the time of the exercise of the NQO.
SARs are designed to provide sufficient liquidity to
allow the executive to pay the tax due at exercise.
IV. STOCK APPRECIATION RIGHTS
AND OTHER PHANTOM EQUITY PLANS
A. Description.
A stock appreciation right (SAR) is a
contractual right to receive a cash payment based on
the value or increase in value in the company’s
stock. The SAR payment can be tied to: (a) a fixed
settlement date; (b) the executive’s exercise of the
SAR; or (c) upon certain events (such as sale of the
company). A phantom equity plan is where the
executive is granted an “interest” in a phantom
ownership account. Employer promises to pay the
value of all vested fictional interests in the executive
account at a specified future date. A performance
unit plan uses a more specific performance
measurement (e.g., performance of a division) in
lieu of overall company performance when
determining amount of reward to be received by the
executive. SARs and other phantom equity plans
may be subject to a vesting schedule. The tax
consequences of SARs and other phantom equity
plans are the same.
B. Executive’s Tax Consequences
1. Grant.
Executive is not subject to tax on grant of
award. The grant is treated as an unfunded,
unsecured promise to pay that is not “property” for
purposes of IRC § 83. Treas. Reg. § 1.83-3(e); PLR
8230147.
2. Payment.
Executive recognizes compensation income
when he receives payment pursuant to the award.
C. Advantages
12
D. Disadvantages
1. Least favorable to executive because entire
amount received by executive is treated as ordinary
compensation income.
2. Executive may prefer a “true equity”
interest to a SAR.
V. Employee Stock Purchase Plan
A. Description
An employee stock purchase plan (“ESPP”)
is a type of stock option plan that permits an
employee to purchase company stock at a discount
compared to the market value on the date of
exercise of the option. The employee elects whether
to contribute from his after-tax compensation to the
purchase of the company stock at the ESPP price. If
the employee so elects, the option automatically
exercises at the end of the specified period.
1. Example
A typical ESPP offers semi-annual
purchase periods. All eligible employees have
the option to buy company stock on the last
business day of each purchase period at a price
that is 85% of the average of the market value
of the stock on the lower of (i) the first day of
the period and (ii) the last day of the period.
Before the purchase period starts, the employee
elects whether or not to participate. If the
employee participates then after tax funds are
withheld from each pay period and the amount
accumulated at the end of the period
automatically is applied to purchase company
stock. In contrast to a 401(k) plan, the funds