Equity compensation awards by privately owned corporations are typically structured as either grants of stock options or issuances of restricted stock. In general, the goal of the award recipient is to defer his or her obligation to pay the purchase price and tax costs of the award for as long as possible and to maximize the portion of his or her income from the award that is taxable at long-term capital gain rates.1 Stock options can be attractive to the recipient because, within specified parameters, they allow the recipient to decide in the future whether and when to pay the purchase price for the award. Often, however, the recipient of a stock option reports most or all of his or her income at ordinary income rates, or at least has to pay tax upon exercising the option, even if the option is issued as a supposedly tax-favored “incentive stock option” (or “ISO”). The infirmities in the option rules sometimes cause the parties to equity compensation transactions to consider the use of restricted stock as an alternative. This article reviews and compares the tax aspects of compensatory stock option grants and restricted stock awards by corporations.
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