2013-Issue 33—This edition of Tax Advisor Weekly discusses some of the common compensation tax issues that occur when U.S. corporations are acquired.
Recently, there has been an increase in the number of strategic mergers and foreign inbound investments. These types of transactions raise numerous U.S. tax issues relating to equity compensation. If not handled appropriately, the tax exposure to the acquired corporation and its executives can be significant.
Overview of Equity Compensation
Companies often grant their employees equity compensation awards to retain and reward key talent for the performance of services. These awards typically vest over time based on the employee’s continued employment. The most common forms of equity compensation are stock options and restricted stock awards. Stock options are either nonqualified stock options (NQSOs) or incentive stock options (ISOs).
NQSOs are normally not taxable to the recipient when granted, but are taxable upon exercise. This assumes that the options have an exercise price equal to or greater than the stock’s fair market value, in order to comply with IRC Section 409A. Upon exercise, the excess of the fair market value of the stock over the exercise price (the “spread”) is taxable to the employee as ordinary income. The company is entitled to deduct the spread in the year of exercise.