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What Every Employee Should Know About Stock Compensation

By Contributor
Accounting and Tax Planning Special Coverage

Unlocking the Benefits

 

By Matt Baran

Stock compensation has become an increasingly common form of employee compensation, particularly in tech startups, large corporations, and publicly traded companies. This form of compensation allows employees to benefit from their company’s success by offering them the ability to acquire shares of the company’s stock. Stock compensation also allows companies to save cash while still providing their employees with a form of payment.

There are different types of stock compensation plans available, each with its own set of benefits and tax implications. The most common types are incentive stock options (ISOs), non-qualified stock options (NSOs), and restricted stock units (RSUs). Understanding these options is essential for employees to make informed decisions about their compensation and plan for potential tax obligations.

 

Incentive Stock Options

Incentive stock options are a type of stock option that provides employees the right to purchase company shares at a fixed price (known as the exercise price) after a certain vesting period.

ISOs have unique tax advantages that make them appealing to employees. When employees exercise ISOs and hold onto the shares for at least one year after exercise and two years after the grant date, any gains from the sale of the stock are taxed as long-term capital gains rather than ordinary income, providing favorable tax treatment as long-term capital gain rates are typically lower than ordinary tax rates.

ISOs do not trigger ordinary income tax when they are exercised, as long as the employee meets the holding-period requirements previously mentioned. This allows employees to potentially defer taxes until they sell the shares. If the holding-period requirements are not met, the sale would be considered a disqualified disposition and subject to ordinary tax rates, on both the spread and any additional gains after purchase.

Matt Baran

Matt Baran

“Restricted stock units are valuable because they provide employees with an equity stake in the company once the shares vest. Unlike stock options, which have value only if the company’s stock price rises above the exercise price, RSUs have intrinsic value as long as the company’s stock has value.”

While ISOs provide the benefit of capital-gains tax treatment, they come with the risk of triggering alternative minimum tax (AMT). The spread between the exercise price and the fair market value of the stock at the time of exercise is considered a preference item for AMT purposes, potentially causing employees to owe additional taxes even if they do not sell the stock immediately. Any AMT paid in a tax year can typically be taken as a credit in the next year the taxpayer is not subject to AMT.

 

Non-qualified Stock Options

Non-qualified stock options are the most common type of stock options granted by companies. Similar to ISOs, employees are granted the right to purchase shares at the exercise price. Unlike ISOs, NSOs do not receive the same favorable tax treatment and can trigger tax consequences at the time of exercise.

When an employee exercises NSOs, the difference between the exercise price and the fair market value of the stock is taxed as ordinary income. This means that the employee will face immediate income-tax liability on the spread at exercise. The combination of the amount paid for the shares plus the taxable spread upon exercise becomes the tax basis in the shares and will be used in the calculation of gain or loss when the shares are sold. Any gains or losses will be treated as capital gains, either short- or long-term, depending on the holding period.

 

Restricted Stock Units

Restricted stock units are valuable because they provide employees with an equity stake in the company once the shares vest. Unlike stock options, which have value only if the company’s stock price rises above the exercise price, RSUs have intrinsic value as long as the company’s stock has value. Vesting, in relation to RSUs, is typically on a time-based schedule.

There are also performance stock units (PSUs), in which an employee must hit certain performance metrics to trigger the stock to vest. RSUs and PSUs are treated the same for tax purposes.

The shares are taxed at their fair market value when they vest, and employees usually elect a ‘sell-to-cover’ withholding method, meaning a portion of the vested shares are sold immediately to cover federal, state, and FICA withholdings. Employees with high tax rates should be conscientious of the withholding rate and consider making additional estimated tax payments, if necessary.

The fair market value that is taxable upon vest becomes the tax basis in the shares. Any gains or losses from sales of that stock are capital in nature and will be taxed at either short- or long-term rates, depending on the holding period.

 

Planning for Stock Compensation

Planning is paramount regarding stock compensation. It is important for employees to be aware of the relevant dates, including the grant date, exercise date, vesting date, and holding period once the employee gains ownership of the shares. For all types of stock compensation, employees must understand what type of stock compensation they were granted and the nature and timing of taxation, and have a plan for managing cash flows and executing sales of the stock down the road.

There are other planning considerations, including the long-term outlook of the company, the employee’s personal portfolio and diversification, and how other sources of taxable income impact tax liabilities and tax rates.

 

Bottom Line

Employees should carefully consider the type of stock compensation they receive and plan accordingly to manage their tax liabilities and maximize the benefits. As always, consulting a tax professional is recommended to navigate the complexities of stock compensation.

 

Matt Baran is a tax manager at MP CPAs

Mistakes in Classifying Your Workers Can Be Costly

By Contributor
Banking and Financial Services

Contractor or Employee?

By Sarah Rose Stack

 

Even prior to the pandemic, the ‘gig economy’ was growing at unprecedented rates. That growth has only been accelerated with more traditional companies relying on remote workers and hiring more contractor workers. Freelancing is big business, with nearly $1 trillion of income generated. However, although that total number is impressive, independent contractors earn 58% less than full-time employees (FTEs), and more than half don’t have any employer-provided benefits.

From a business perspective, there are advantages and disadvantages to how a company classifies its workers. With employees, you’ll have more control, but that comes with more compliance obligations. With contractors, you’ll have fewer compliance obligations, but you will also have less control.

“From a business perspective, there are advantages and disadvantages to how a company classifies its workers.”

Some tax advantages to hiring independent contractors include the ability to avoid several tax obligations that apply to employees. For example, a company generally isn’t required to withhold federal or state income taxes, pay the employer’s share of Social Security and Medicare (FICA) taxes, withhold the workers’ share of FICA taxes, or pay federal or state unemployment taxes.

In addition, companies that use contractors may avoid other obligations, such as the requirement to pay minimum wages and overtime under the federal Fair Labor Standards Act and similar state laws, furnish workers’-compensation insurance (in many states), make state disability-insurance contributions, or provide employee benefits.

Keep in mind that simply having a written agreement or labeling a worker as an independent contractor doesn’t make them so. The IRS and other government agencies look at all the facts and circumstances to determine whether workers are misclassified.

When someone is hired, they must be classified as either an employee or an independent contractor. Here’s how the IRS determines worker status.

 

Behavioral Control

If the company has a great deal of control over the behavior of the worker — for example, where they work, when they work, or how they perform their jobs — the worker should be classified as an employee. If the company is giving the worker evaluations, conducting extensive or ongoing training about procedures and methods, or demanding that the worker attend daily meetings or set hours, then the worker is more likely an employee. Independent contractors will customarily set their own hours, decide on how to implement a project, and dictate where they work.

 

Financial Control

If a company provides equipment for the worker (tools, software, computers, phone, etc.), often reimburses expenses, and/or pays on regular and ongoing basis, then the worker is more likely to be an employee. The IRS clarifies by considering the following:

• Significant investment in the equipment the worker uses in working for someone else;

• Unreimbursed expenses, which independent contractors are more likely to incur than employees;

• Opportunity for profit or loss, which is often an indicator of an independent contractor;

• Services available to the market, as independent contractors are generally free to seek out business opportunities; and

• Method of payment. An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time even when supplemented by a commission, while independent contractors are most often paid for the job by a flat fee.

 

Relationship

Perception of the relationship is considered, but the interactions between workers and employees is what ultimately defines the relationship. Written contracts are considered; however, an employer cannot classify their workers as independent contractors when they, in fact, treat them like employees. If the company is providing employee benefits, insurance, paid time off, sick days, or pension plans, then the worker is most likely an employee.

Another area to consider is the permanency of the relationship. Employees are more likely to be hired indefinitely, and either party can terminate the relationship at any time, for any legal reason. Independent contractors’ rights are subject to a contract.

 

Penalties for Misclassifying Workers

The consequences for misclassifying employees as independent contractors can include IRS penalties and other non-tax implications. The IRS may assess back taxes against the company and demand that the company pay the employees’ share of unpaid payroll and income taxes, regardless of whether or not the independent contractors met those tax obligations. Companies can also expect to pay IRS penalties and interest. Further, workers can file a lawsuit against employers to demand back pay, overtime, and benefits.

 

Review Your Current Workers’ Status and Hiring Policies

The potential tax and non-tax savings do not outweigh the significant cost of misclassifying workers. It’s important to review your hiring policies, even if you are comfortable with your classification of current workers, to ensure that you are meeting all applicable standards for classification. Talk with your advisors if you believe you may have misclassified an employee or have questions about the standards.

 

Sarah Rose Stack is the Marketing manager for Holyoke-based accounting firm Meyers Brothers Kalicka, P.C.

Northern Tree Service Transitions to Employee Stock-ownership Plan

By
Daily News

PALMER — Northern Tree Service Inc. announced it has transitioned the ownership of its business lines over to an employee stock-ownership plan, or ESOP.

The Lazear Capital Partners team worked with the management of Northern Tree Service to design a custom solution that included employee benefits, financial flexibility, and maximum tax advantages.

Founded in 1932 by Walter Cambo, the company was first established to service state and municipal tree work in Eastern Mass. Under the leadership of Paul Cambo, Northern Tree Service grew to provide land-clearing services for the ever-expanding energy grid in the Northeast. Furthering Northern’s expansion, now under the leadership of Paul’s son, Philip, Northern Tree Service has continued its growth to become one of the most diversified tree-care companies in the industry, servicing all New England and surrounding states.

“With the history of our employees’ dedication to the company comes personal responsibility for me to develop a succession plan that will help ensure its continued success, further strengthen its legacy, and reward all employees dedicated to the future of Northern Tree,” CEO Philip Cambo said. “While there were many succession plans available to Northern Tree, only one was the perfect fit to address my responsibility to the company. I’m proud to say that Northern is now 100% employee-owned through this newly formed ESOP.”

Added President Timothy LaMotte, “the ESOP was the choice we made to maintain the business’s current direction while simultaneously rewarding the 250-plus employees that have been so critical to the business’ success. We have a very specialized and highly skilled group of professionals focused on safety and integrity, and we are excited to see that continue.”

With the new ESOP in place, both Cambo and LaMotte will continue their current roles for the foreseeable future and gradually hand over the business’ operational control to the next generation of leaders.

Employee ownership through an ESOP is a retirement plan that allows employees to have an ownership stake in the firm through a qualified trust. Over time, employees earn an equity stake in the company’s shares through no cost to them. In practice, ESOPs encourage companies to stay rooted in a single place and generally keep employee turnover low because they reward tenure with more significant financial stakes.

There Are Some Significant Differences When It Comes to Taxes

By
Accounting and Tax Planning

Employee or Contractor?

By Danielle Fitzpatrick

Taxpayers often ask about the difference between being an independent contractor and an employee. Although it may seem like they both perform similar work, there are some significant differences when it comes to their responsibilities and when filing annual income-tax returns.

Perhaps you are currently working for an employer and are considering becoming a contractor, or maybe you have just graduated college with a degree and are trying to decide which option is best for you. Whichever route you decide to take, it is important to know the differences so that you can plan accordingly.

Differences in Responsibilities

You are considered an employee when the business you work for has the right to direct and control the work you perform. You are given specific instructions on when and where to work, and are often provided training and the necessary equipment needed to perform specific duties. As an employee, you receive regular wages and may be eligible for benefits such as insurance, retirement, vacation, and sick pay.

You are considered a contractor when services are provided for a specific period of time. Rather than being paid a regular wage, you are paid a flat fee for contractual services. As an independent contractor, you are not eligible for benefits or training through the businesses you are performing services for. You are in charge of your own schedule and typically have several clients for which you are providing services.

Differences at Tax Time

One of the biggest differences between being an employee and a contractor is how your income is taxed on your income-tax return. Unfortunately, the difference is often not realized until an individual files their return and is faced with a significant tax burden.

As an employee, your employer pays 50% of your Medicare and Social Security (FICA) taxes. The other 50% is withdrawn from your regular paycheck along with federal and state (if applicable) tax withholdings. If any expenses are incurred and unreimbursed by your employer, the expenses are not deductible for the employee. On an annual basis, you receive a Form W-2, which shows your taxable income along with all taxes that you had withheld throughout the year.

“One of the advantages of being a contractor is that you can deduct expenses you incur in relation to the income you receive. Record keeping is extremely important when becoming self-employed in order to ensure that you are tracking all applicable income and expenses.”

As a contractor, you are considered self-employed (a sole proprietor). You are now responsible for 100% of the FICA taxes, also known as self-employment taxes. No federal or state tax withholdings are withdrawn from the income you receive, and you may be required to make quarterly estimated tax payments. On an annual basis, you receive a Form 1099-MISC showing the gross income you received in excess of $600 for each business you performed services for. All of the income you receive as a contractor is reportable on Schedule C, which is filed with your individual income-tax return, or on a business tax return if you choose to become incorporated.

One of the advantages of being a contractor is that you can deduct expenses you incur in relation to the income you receive. Record keeping is extremely important when becoming self-employed in order to ensure that you are tracking all applicable income and expenses. Expenses that may help offset your income include, but are not limited to, vehicle expenses, travel expenses, supplies, fees paid for continuing education, and the renewal of professional licenses.

Some Examples

Say you are an employee making $25 an hour and working 40 hours a week. For this example, note that nothing is being withheld for benefits. Your paycheck would look like the following:

Weekly Pay ($25 x 40 hrs.) $1,000
Less:
Federal Taxes Withheld       $200
State Taxes Withheld             $50
FICA Taxes Withheld             $77
Total Weekly Pay              $673

Now, say you are a contractor and charge $25 an hour to provide services to three businesses totaling 40 hours for the week. You receive a total of $1,000 for the week. In addition, you purchased $30 in office supplies and drove 250 miles for the week. Your net income for the week would be:

Gross Income             $1,000
Less:
Office Supplies                $30
Mileage Expense           $145
Taxable Net Income    $825

Now you’re thinking, why am I not a contractor? I bring home over $300 more a week! Yes, you bring home more for the week, but you cannot forget that taxes are not being withheld from your income. You will be responsible for paying these taxes on a quarterly basis and/or when you file your tax return.

As an employee, you report $1,000 as taxable wages on your income-tax return, from which federal and state taxes have already been withheld and will hopefully cover your tax liability. As a contractor, you have taxable net income of $825, but you are now responsible for self-employment tax, in addition to regular income tax that you have not yet paid.

Conclusion

So, should you become an independent contractor or an employee? There is no right or wrong answer; each individual needs to make their own decision and determine what will work best for them and their situation. However, whichever route you decide to take, be sure to consult your tax professional for advice to eliminate any potential surprises and ensure that you are prepared when it comes to filing your annual income-tax returns.

Danielle Fitzpatrick, CPA, is a tax manager at Melanson Heath. She is part of the Commercial Services department and is based out of the Greenfield office. Her areas of expertise include individual income taxes and planning, as well as nonprofit taxes. She also works with many businesses, helping with corporate and partnership taxes and planning.

One Key to Improvement Is Focusing on Culture, Not Individuals

By
Workforce Development

The Truth About Employee Disengagement

By Brad Wolff

Most companies struggle with employee disengagement. It’s costly in productivity, profitability, and stress. Gallup’s engagement survey data published in 2017 found that two thirds of U.S. workers are not engaged.

American companies have invested billions of dollars per year for many years to solve this problem. The results? The needle still hasn’t moved. How much has your experience been similar? Could this data simply reveal a general misunderstanding of the true causes of disengagement?

The Acme Corporation was suffering a 41% turnover rate. A recent survey showed that 85% of their workforce was disengaged. The general attitude of apathy, complaining, and cynicism permeated the culture. This was puzzling to management since they attempted multiple efforts to improve engagement.

These were well-planned and executed programs such as team-building exercises, social events, and pay raises. All showed early enthusiasm and positive survey results that generated optimism. Unfortunately, the magic always wore off within a few weeks. In despair, Acme engaged a firm with a very different philosophy than their other advisors. This firm focused on helping executive leadership understand the root causes and solutions. Within nine months, disengagement improved from 71% to 26% and turnover dropped to 19%.

The door to solving this dilemma opened when Acme management acknowledged that since their previous solution attempts were ineffective, their current way of seeing the problem must be flawed. This wisdom, humility, and openness paved the way to learn the true root causes of their disengagement. Once root causes are clearly understood, the solutions usually become obvious.

Fixing engagement issues: What works?

The first step is for the company leaders to take an honest, objective view of the company culture (beliefs and behaviors that determine how people interact and do their work) that impacts and drives the way people think and behave.

That’s why lasting change occurs when focusing at the culture level rather than specific individuals. Below are the relevant human psychological needs that are the actual root causes of people’s engagement level. Examples of mindsets/philosophies that effectively address these needs follows each need. Engagement will improve when management’s actions align with people’s psychological needs.

• To feel valued and understood. Management earnestly listens to employees’ concerns, opinions, and ideas with the intent to understand and consider their merits before responding. This replaces the common responses of defending positions or punishing employees for expressing contrary viewpoints. Management isn’t required to agree with the employees. What’s important is the sincere effort to listen, understand and consider their inputs.

• To express our gifts and talents. Management puts a focus on aligning roles and responsibilities with the gifts and talents of the individuals. We all bring a substantially higher energy and engagement (and productivity) when we do work that we like and are good at. As legendary management consultant Peter Drucker said, “A manager’s task is to make the strengths of people effective and their weaknesses irrelevant.”

• Meaning/purpose in what we do. This means that employees have a clear understanding of how their work impacts the mission and vision of the organization. Don’t expect them to figure this out on their own. People are much more motivated when they realize that their efforts truly matter.

• Internal drive for progress or development. Employees are at their best when there is “healthy tension” (not too low, not too high) to meet clear and reasonable standards. This means fair and consistent accountability and consequences based on performance relative to agreed-upon standards. Being too nice and lax harms engagement since people inherently desire growth and realize that standards and consequence help them do this. People are motivated when they focus on: “What did I achieve today?” What did I learn today?” How did I grow?”

What doesn’t work:

In short, anything that doesn’t authentically address the root causes of disengagement is doomed to fail. If the message is ‘look at this nice thing we just did for you’ rather than ‘this is how we value you as human being,’ it’s highly likely to fail.

Examples of the ‘nice thing we just did for you’ include most team-building events, social mixers, company newsletters, upgraded office environments, etc. Even pay and benefit increases have an initial rush soon followed by the familiar “right back where we were” rebound effect. That’s not to say companies should not do these things. They’re nice add-ons after the day to day essentials of human psychology are authentically addressed.

In summary, it’s understandable that we gravitate toward easy, quick-fix solutions to our problems. There are plenty of people to make these suggestions and sell them to us. They also don’t require us to identify our own personal contributions to the problems which we’d prefer to avoid. However, as in most things in life, there is no substitute for working at the cause-level and creating new habits of thinking and behavior.

If you’re serious about creating the high engagement level lead to more profits with greater ease and personal satisfaction, this is what it takes. As a bonus, openly addressing personal challenges that make you human will increase your effectiveness and fulfillment in every area of your life.

Brad Wolff specializes in workforce and personal optimization. He’s a speaker and author of, People Problems? How to Create People Solutions for a Competitive Advantage. As the managing partner for Atlanta-based PeopleMax, he specializes in helping companies maximize the potential and results of their people to make more money with less stress; www.PeopleMaximizers.com.