1. Copyright © 2007, The American College. All rights reserved. Used with permission. Planning for Retirement Needs Equity Based Compensation Plans Chapter 16

2. Copyright © 2007, The American College. All rights reserved. Used with permission. Chapter 16: Equity Based Compensation Comparing qualified and nonqualified plans Tax considerations Funding Installation and administration

3. Copyright © 2007, The American College. All rights reserved. Used with permission. Reasons for Equity-based Compensation Incentive for employees Employees feel valued Less costly than cash Long-term capital gains Start-up companies cash is short Not subject to qualified plan requirements

4. Copyright © 2007, The American College. All rights reserved. Used with permission. Assessing The Closely Held Business Stock valuation Mechanism for repurchasing stock Placing employee at risk Tax consequences Corporate structure Legal and accounting aspects

5. Copyright © 2007, The American College. All rights reserved. Used with permission. Stock-Option Plans Nonqualified stock options ISO—Incentive stock options Employee stock purchase plans

6. Copyright © 2007, The American College. All rights reserved. Used with permission. Nonqualified Stock Options Options granted for a specified period at a set (usually current market value) price At exercise, participant purchases stock Ordinary income that is difference between option price and market price at exercise Employer gets a deduction in this amount Long- or short-term capital gain from time of exercise to time of sale

7. Copyright © 2007, The American College. All rights reserved. Used with permission. Nonqualified Option Design Option duration Impact of termination Vesting provisions Cashless transactions

8. Copyright © 2007, The American College. All rights reserved. Used with permission. ISOs (rules) Option price is equal to or greater than current market value Duration can not exceed 10 years Approved by board of directors $100,000 limit 10% shareholder

9. Copyright © 2007, The American College. All rights reserved. Used with permission. ISOs (Tax treatment) No income tax at time of exercise (alternative minimum tax) Tax at time of sale—long-term capital gain if holding-period requirements met –2 years from grant –1 year from exercise No employer deduction at all

10. Copyright © 2007, The American College. All rights reserved. Used with permission. Choosing a Plan Employer may prefer nonqualified due to tax deduction Employees prefer ISO tax treatment Employer can establish nonqualified and provide bonus to simulate ISO tax

11. Copyright © 2007, The American College. All rights reserved. Used with permission. Exercising Options Know the rules Consider factors in text Make a long-term liquidation plan

12. Copyright © 2007, The American College. All rights reserved. Used with permission. Employee Stock Purchase Plans Code Sec 423 discount program Approved by stockholders Exclude 5% owners Include full-time employees with 2 years of service $25,000 limit Valuation/accounting/securities law/administrative issues

13. Copyright © 2007, The American College. All rights reserved. Used with permission. Employee Stock Purchase Plans 15-percent discount –Can be price at beginning of period –Or price at time of purchase No tax until sale of stock Long-term capital gain if holding period met –2 years from grant –1 year from purchase

14. Copyright © 2007, The American College. All rights reserved. Used with permission. Employee Stock Purchase Plans Value of discount –15-percent discount = 17.6% return Example –Stock value $10 purchase for $8.50 –$1.50 return on $8.50 investment is 17.6% Look-back price can be more valuable

15. Copyright © 2007, The American College. All rights reserved. Used with permission. Restricted Stock Executive granted shares of stock Title identifies forfeiture events (vesting) Dividend usually paid More secure than typical deferred comp. No cost to employee Taxed at time risk of forfeiture lapses Sec. 83 election to tax at time of grant

16. Copyright © 2007, The American College. All rights reserved. Used with permission. Restricted Stock Example: Company grants to Billy Bigshot 200 shares of stock worth $10,000. The stock will be forfeited unless Billy works until age 65, at which time the stock becomes freely transferable by Billy. At age 65, Billy retires and decides to hold the stock, which is now valued at $8,000.

17. Copyright © 2007, The American College. All rights reserved. Used with permission. Phantom Stock Bookkeeping entry Value of the units generally equals the market value of the underlying stock Fixed maturity date Could credit account with dividends Payout usually based on the appreciation in value of the stock No cost to employee

18. Copyright © 2007, The American College. All rights reserved. Used with permission. Phantom Stock Example: Employer grants Executive A 100 shares of phantom stock valued at $5,000 ($50 per share). The phantom stock matures, and 5 years later its value has increased to $7,500 ($75 per share). At that time, the employer pays the employee $2,500, the difference between the value at the time of the grant and the value at the time of maturity.

19. Copyright © 2007, The American College. All rights reserved. Used with permission. SAR Right to receive increase in value of stock during a specified period Can exercise SAR during option period Example: Wanda has SAR for 1,000 shares at $100 a share –Exercise 100 when value rises to $110 –Exercise 900 when value rises to $200 Employee ordinary income, employer receives deduction

20. Copyright © 2007, The American College. All rights reserved. Used with permission. True/False Questions George has one nonqualified stock option with an option price of $10. If George buys the stock when the market value is $50, George has $50 of ordinary income and the employer receives a deduction of $50. A phantom stock plan typically provides an award based on the appreciation in the value of stock on a specified maturity date.