Stock Options and Restricted Stock               Equity                                         Andrew T. Mirsky          ...
Andrew T. Mirsky, Esq.• Principal, Mirsky & Company, PLLC, DC and NY• Formerly in-house counsel with National Journal  and...
Two Types of Stocks    ISOs       •Incentive (Incentive)               •(Non-statutory or   NSOs         Nonqualified)
Who May Receive?ISOs• Employees only (and must be exercised within 3  months of leaving company)NSOs• Employees and contra...
PricingISOsMust be granted at (or above) fair marketvalue. (Section 409A Rules)NSOsCan be priced below (or above) currentm...
Holding Period                      ISOs             1+ year from exercise              and 2+ years from               gr...
When taxable to recipient?        • Not taxable upon grant. Not taxable          upon exercise. Taxable only upon         ...
What Type of Tax?       Taxable upon disposition (not exercise) atISOs   capital gains rate, based on appreciation       b...
Deductibility (for Company)ISOsNot deductible as compensationNSOsCompany gets deduction (at exercise, notgrant). This can ...
When Exercised              ISOsMust be exercised within 3 months  of termination of employment (otherwise, gets treated a...
AMTISOs•Potentially ProblematicNSOs•Practically speaking, not affected.
Restricted StockStock (i.e. actual stock, not options) that is“substantially nonvested”, meaning:Subject to “substantial r...
Who May Receive?Employees and non-employees• Contractors• Freelancers• Vendors, etc.
Pricing If stock has value • employee required to pay $$ for   purchase (unlike options) • Otherwise, grant = compensation...
Holding PeriodTypically• forfeiture and repurchase terms allowing  buyback at cheap cost if grantee leaves  company during...
When taxable to recipient?No income tax upon grant until vesting restrictions lapse       Then tax as compensation at ordi...
Deductibility (for Company)        Does the Grantee make        83(b) election?                   If yes:        • Company...
Q+AQ: AMT implications – how might the AMT beincreasingly reducing tax benefits of ISOs? Is                  this true?
Q+AA: Yes, it’s possible. For ISOs, benefits of (a) no    tax on exercise and (b) deferred tax untildisposition possibly o...
Q+AQ: Section 83(b): S corps often require restricted     stock recipients to make 83(b) election. (Otherwise, employee ow...
Q+A  A: (If recipient does not make a Section 83(b)  election, he or she is not deemed to own the    stock for tax purpose...
Q+A   A (cont.): It is not unusual, therefore, for S corporations to require recipients of restrictedstock to make Section...
Q+AQ: Are these the only ownership options for                employees?
Q+AA: No
Q+A  Q: What about founders – what kind of              ownership?  Q: What about vesting and forfeiture?Q: What kinds of ...
Q+AQ: Why would a company not want to issueNSOs? Since company gets a deduction forcompensation, wouldn’t this be attracti...
Q+AA: LLCs. Options difficult with LLC “membership    interests”, and ISO tax treatment not IRS-                recognized...
Q+A    Q: (Company perspective) Under whatcircumstances would a company want to issuerestricted stock in preference to sto...
Q+A   A: (1) Gives employees better sense of true, immediate “ownership”, (2) less cumbersomethan dealing with IRS option ...
Q+A    Q: (Company perspective) Under whatcircumstances would a company want to issuestock options in preference to restri...
Q+A A: (1) Does not actually give up ownership yet, and not having to deal with new shareholder demands,     (2) (with NSO...
Q+AQ: What is the major distinction between   restricted stock and stock options?
Q+A   A: With restricted stock, grantee becomesactual shareholder immediately (but not for tax    purposes unless 83(b) el...
Andrew T. Mirsky                 andy@mirskylegal.com                    (202) 339-0303                  www.mirskylegal.c...
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Stock and Restricted Stock Equity

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Ever wonder what the pros and cons to stock options are? Well, wonder no more- that information is here for you! In addition, this presentation provides valuable information for both emploees and employers and fast facts about non-statutory or non'qualified stock options which may be issued to employes as well as non-employees such as contractors and freelancers. Andrew Cooper, CPA (Quinn Lobel & Associates, P.C.) co-hosts.

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Stock and Restricted Stock Equity

  1. 1. Stock Options and Restricted Stock Equity Andrew T. Mirsky Mirsky & Company, PLLCMirsky & Company, PLLC (“Kenyon”) has provided this presentation for general informational purposes only. It is not intended as professionalcounsel and should not be used as such. You should contact your attorney to obtain advice with respect to any particular issue or problem.
  2. 2. Andrew T. Mirsky, Esq.• Principal, Mirsky & Company, PLLC, DC and NY• Formerly in-house counsel with National Journal and Atlantic Monthly magazines• Clients in new media and technology, including intellectual property, corporate and finance, privacy, joint ventures and partnerships, and employment and HR matters.• Founder, Media Future Now (www.mediafuturenow.com)
  3. 3. Two Types of Stocks ISOs •Incentive (Incentive) •(Non-statutory or NSOs Nonqualified)
  4. 4. Who May Receive?ISOs• Employees only (and must be exercised within 3 months of leaving company)NSOs• Employees and contractors and anybody else. NSOs can be given to anyone, including vendors, partners, freelancers, your mother … anybody.
  5. 5. PricingISOsMust be granted at (or above) fair marketvalue. (Section 409A Rules)NSOsCan be priced below (or above) currentmarket value.
  6. 6. Holding Period ISOs 1+ year from exercise and 2+ years from grant. Required. NSOsnone, BUT: if disposition occurs prior to 1 yearafter exercise, taxed at ordinary, not cap gains.
  7. 7. When taxable to recipient? • Not taxable upon grant. Not taxable upon exercise. Taxable only upon disposition of underlying stock, and at ISOs (more favorable) capital gains rate. Therefore: If never exercised, never taxable. • Not taxable upon grant. Taxable at exercise (ordinary) based on spreadNSOs between exercise price and FMV. Taxable upon disposition (cap gains or ordinary), and at higher basis than ISO.
  8. 8. What Type of Tax? Taxable upon disposition (not exercise) atISOs capital gains rate, based on appreciation between exercise price and price at disposition.NSOs Taxable at exercise as ordinary income, and taxable upon disposition at capital gains rate.
  9. 9. Deductibility (for Company)ISOsNot deductible as compensationNSOsCompany gets deduction (at exercise, notgrant). This can be significant.
  10. 10. When Exercised ISOsMust be exercised within 3 months of termination of employment (otherwise, gets treated as NSO. NSOs No limitation.
  11. 11. AMTISOs•Potentially ProblematicNSOs•Practically speaking, not affected.
  12. 12. Restricted StockStock (i.e. actual stock, not options) that is“substantially nonvested”, meaning:Subject to “substantial risk of forfeiture”, i.e.subject to repurchase at less than FMV if employeeleaves Company and “non-transferable” withoutrisk of forfeiture. Restricted StockGrantee is true “shareholder” with all rights ofowners (voting rights, distribution rights,information rights, etc.).
  13. 13. Who May Receive?Employees and non-employees• Contractors• Freelancers• Vendors, etc.
  14. 14. Pricing If stock has value • employee required to pay $$ for purchase (unlike options) • Otherwise, grant = compensationHowever, with newcompanies with startup value• stock may not yet have value, so cost may be negligible.
  15. 15. Holding PeriodTypically• forfeiture and repurchase terms allowing buyback at cheap cost if grantee leaves company during “holding” periodAs with any stock ownership• possible shareholder restrictions on transferability
  16. 16. When taxable to recipient?No income tax upon grant until vesting restrictions lapse Then tax as compensation at ordinary income rate Section 83(b) election: Grantee may elect or recognize income immediately (rather than post-vesting and post-appreciation) upon grant based on FMV of underlying stock • Downsides: 1. pay tax now, but at a potentially lower rate than later and 2. potential forfeiture
  17. 17. Deductibility (for Company) Does the Grantee make 83(b) election? If yes: • Company gets deduction for compensation. No? • Then company gets deduction when restrictions relapse
  18. 18. Q+AQ: AMT implications – how might the AMT beincreasingly reducing tax benefits of ISOs? Is this true?
  19. 19. Q+AA: Yes, it’s possible. For ISOs, benefits of (a) no tax on exercise and (b) deferred tax untildisposition possibly offset by obligation to payAMT based on disposition. Additional problem of difficulty to calculate.
  20. 20. Q+AQ: Section 83(b): S corps often require restricted stock recipients to make 83(b) election. (Otherwise, employee owns stock and may be legally entitled to all rights as a shareholder (including distributions), but may not be responsible for taxable share of profits.) So, requiring 83(b) election causes employee torecognize income now and thus dilutes taxable income of all owners.
  21. 21. Q+A A: (If recipient does not make a Section 83(b) election, he or she is not deemed to own the stock for tax purposes until vesting. Any distributions made with respect to the stock before vesting are treated as compensationpayments. If the corporation is an S corporation, the recipient does not report any of the corporation’s undistributed income, even though he or she might be entitled to receive a share of the income if later distributed.
  22. 22. Q+A A (cont.): It is not unusual, therefore, for S corporations to require recipients of restrictedstock to make Section 83(b) elections. Absent a Section 83(b) election, the shares are not treated as being outstanding for S corporation qualification purposes until they have vested.)
  23. 23. Q+AQ: Are these the only ownership options for employees?
  24. 24. Q+AA: No
  25. 25. Q+A Q: What about founders – what kind of ownership? Q: What about vesting and forfeiture?Q: What kinds of companies can issue stock options? LLCs? S corps?
  26. 26. Q+AQ: Why would a company not want to issueNSOs? Since company gets a deduction forcompensation, wouldn’t this be attractive?
  27. 27. Q+AA: LLCs. Options difficult with LLC “membership interests”, and ISO tax treatment not IRS- recognized for LLCs. Restricted stock structure more flexible than options, since options must comply with IRS rules.
  28. 28. Q+A Q: (Company perspective) Under whatcircumstances would a company want to issuerestricted stock in preference to stock options?
  29. 29. Q+A A: (1) Gives employees better sense of true, immediate “ownership”, (2) less cumbersomethan dealing with IRS option rules (e.g. FMV and Section 409A valuation rules), (3) somewhat easier to tailor transfer and other restrictions
  30. 30. Q+A Q: (Company perspective) Under whatcircumstances would a company want to issuestock options in preference to restricted stock?
  31. 31. Q+A A: (1) Does not actually give up ownership yet, and not having to deal with new shareholder demands, (2) (with NSOs) company gets compensation deduction at exercise, (3) For key employees, incentivizes success of Company and thus improve “spread” between stock value and exercise price, (4) inability to run as a pass-through entity (S-corp)if too many stockholders), (5) requirements of x% ofstockholders for approval of corporate transactions, etc.
  32. 32. Q+AQ: What is the major distinction between restricted stock and stock options?
  33. 33. Q+A A: With restricted stock, grantee becomesactual shareholder immediately (but not for tax purposes unless 83(b) election). Stock is actually issued to the employee (or non- employee), subject to vesting and Company repurchase rights.
  34. 34. Andrew T. Mirsky andy@mirskylegal.com (202) 339-0303 www.mirskylegal.com @mirskylegal2301 N Street, NW 318 West 14th StreetSuite 313 4th FloorWashington, DC 20037 New York, NY 10014

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