USA Law and Practice Contributed by: D. Scott Bennett, Nicholas A. Dorsey, Virginia M. Anderson and Ellen H. Park, Cravath, Swaine & Moore LLP
ing of income inclusion as well as the ability to satisfy tax withholding obligations. Restricted Stock Generally, restricted stock is not taxed at grant and is taxed at ordinary income rates on the FMV at vesting (minus any amount paid for the shares). These amounts are generally subject to tax withholding. Employees may have difficulty satisfying these tax obligations, given that the stock is likely illiquid and the FMV may have increased. To avoid this consequence, employ - ees frequently make an election under Section 83(b) of the US Code to be taxed at ordinary income rates on the FMV (minus any amount paid for the shares) at the time of grant. Capital gains rates apply upon disposition of the stock. If, however, an employee forfeits the restricted shares following a Section 83(b) election, the taxes paid may not be recovered and a capital loss may be unavailable. To be effective, a Sec - tion 83(b) election must be made within 30 days NQSOs and RSUs are not taxed at grant. NQSOs are taxed at ordinary income rates at exercise on the “spread” between the exercise price and the FMV. Similarly, RSUs are taxed at ordinary income rates at settlement based on the FMV. These amounts are subject to tax withholding. Capital gains rates apply upon disposition of the stock. of the grant date. NQSOs and RSUs Like restricted stock, NQSOs and RSUs present issues for employees with limited liquidity to sat - isfy these tax obligations. Employees often hold NQSOs until a liquidity event (such as an IPO or M&A transaction). Growth companies often award double-trigger RSUs, which are subject to time-based vesting conditions plus a require - ment that a liquidity event occurs within a cer -
tain period. If properly structured (including with respect to Section 409A of the US Code), taxa - tion is postponed until the liquidity event. ISOs ISOs generally are not taxed at grant or at exer - cise. If the shares are held until the later of two years after grant or one year after exercise, the eventual disposition is taxed at capital gains rates. If these holding periods are not met (a “disqualifying disposition” ), ISOs are taxed at ordinary rates on the spread at the time of exer - cise. ISOs also present concerns under the alterna - tive minimum tax (AMT), to which high-income individuals such as founders and key employees may be subject. Unlike in the regular tax sys - tem, AMT does not exclude an option’s spread at exercise from income. AMT may also raise issues upon a disqualifying disposition, particu - larly where such disposition occurs following the year of exercise. Phantom Equity Phantom equity awards are taxed at ordinary Venture capital investors generally expect the growth companies they invest in to increase or “refresh” the size of their employee equity incen - tive pool at the time they invest. This becomes a key topic of negotiation because it is ultimately a question of company valuation. Investors in US growth companies expect exist - ing shareholders in the company to bear the dilution caused by increasing the size of the equity incentive pool. As a result, investors are motivated to have the equity incentive pool be income rates when paid. 5.4 Implementation Equity Pool
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