Oct 3, 2022 | Taxation, The Practical Tax Lawyer

With labor shortages currently affecting many industries and with the low national unemployment rate, many private company owners are considering compensation incentives to attract and retain high quality employees. For years, tax counsel have advised private company owners on how to develop and implement equity incentive compensation plans for senior executives and for other key employees. In the current economic environment, many private company owners are expanding those equity incentive plans to include all management levels and, in certain cases, some of their rank-and-file employees, as well.

Taxation Considerations Related to Equity Incentive Compensation Plans - by Robert F. Reilly, CPA - presented by ALI CLE

Tax counsel often advise private companies (and particularly early-stage companies) regarding the use of equity incentives to attract and/or retain talented employees. This employee compensation practice has become particularly popular during the recent periods of labor shortages and low unemployment rates. However, equity incentive compensation plans have income tax consequences—both to the employee recipient and to the employer company. This article summarizes what tax counsel need to know about the taxation issues and the securities valuation issues related to private company equity incentive compensation programs.

With regard to the grant of equity incentives, this article considers what tax counsel need to know about the uncertainties related to the fair market value valuation of private company equity interests. In particular, this discussion: (i) considers the uncertainty related to the valuation of early-stage company equity interests; (ii) is relevant to both the taxation aspects and the valuation aspects of implementing an equity incentive compensation plan at a private company; and (iii) assumes that the objective of such a plan is to assist the private company owner to attract and retain the best employees. As mentioned at the outset of this article, nothing contained herein is intended to provide legal, accounting, or taxation advice.

This discussion focuses on all private companies, including closely held private companies and is particularly relevant to early-stage and development stage private companies (including start-up companies). In a competitive labor market, smaller, more thinly capitalized companies may face a greater need to use equity incentives to attract and retain high-quality employees. And, newer, smaller, and more thinly capitalized companies may experience more valuation uncertainty with regard to both the grant and the taxation of their equity incentives.

CLICK HERE to read the full article, which was originally published in ALI CLE’s The Practical Tax Lawyer.