You Want Your Employees to Have Stock—Here's How to Do It Right - Employee Benefits Law Group (2024)

You’re a smart employer. You’ve gathered a great group of employees and developed them into a high-functioning team. They’ve played a big role in the growth of your company and you want to reward them by giving them a “piece of the pie.” But, think twice—or three times—before you start serving up shares of stock. Without the right guidance, your generosity could lead to unanticipated tax and corporate governance problems, not the tasty treat you intended.

These are the three most common scenarios where employers run into trouble.

Giving Stock to Employees Outright or Selling It to Them at a Discount

To the IRS, there is no such thing as a “gift” between an employer and an employee. The employee will be taxed on the value of anything they receive from the employer that they haven’t paid market price for or isn’t excluded from income as a fringe or other benefit. This means the employee will be subject to income tax on the “gift” and the employer will pay payroll tax. Paying those taxes significantly reduces the value of the stock transfer to the employee. The “gift” doesn’t have the impact you hoped it would and the employee has taxable income they weren’t expecting without the cash to pay it.

You’ll have the same result if you sell stock to an employee at a discount (outside of an Employee Stock Purchase Plan – ESPP). The employee will have taxable income and the employer will owe payroll tax on the value of the stock less the amount the employee paid for it. Giving or selling stock to employees cheap is just inefficient from a tax perspective.

Letting Employees Have Stock with No Exit Strategy

What happens if the rosy relationship between you and your employee sours? No one expects a good relationship to go bad, but you should plan for the possibility even if it seems remote. If your employee starts cursing you, how will you get back the stock they own? Will they hold you hostage for tax distributions? Board seats?

However you transfer stock to employees, you should always decide in advance how the relationship will end. The most common way to do that is with a shareholder agreement that spells out the triggers, timing, and price for the repurchase of an employee’s stock. For example, if they terminate employment on good terms, they are required to sell their stock back to the company or the other shareholders at a predetermined price within 90 days. If they are terminated for cause, they are required to sell their stock back within the same time period, but at a discount.

Letting Employees Have Stock When There’s Really No Need To

What if you could accomplish the goals of transferring stock to an employee without having to transfer actual stock? Many employers use “synthetic equity” as a proxy for actual stock. Synthetic equity is a grant of units that are treated like shares of stock, but do not come with shareholder rights. Depending on how the plan is structured, the employee can cash in at a predetermined time or on the occurrence of a predetermined event and be paid either the full value of their synthetic equity units based on the company’s current stock value or the spread between the value of the company stock at the time of the grant and the value at the time the employee cashes in. If properly designed, a synthetic equity plan keeps employees from being taxed until they cash in and have the cash to pay the tax. It also aligns the employee’s interests with the company’s interests without giving them a seat at the shareholder table.

There are many ways to transfer actual stock or the value of stock to a few or nearly all of your employees. From stock option plans and employee stock ownership plans (ESOPs) to restricted stock and stock appreciation rights plans (SARs), there’s likely a plan design that gives your valued employees the benefits of ownership without incurring unexpected taxes or bringing unwanted voices into your corporate governance. We can guide you to the plan design that helps you retain and recruit the kind of employees smart employers like you are looking for! Let’s start a conversation.