Equity incentive awards such as stock options and restricted stock awards 1 provide a key tool for Founders and early-stage companies to attract, retain, and incentivize key employees and other service providers of the Company.
The basic tax rules state that when an employer gives an employee something of value, the value of the item given to the employee is taxable as ordinary income to the employee.
With respect to grants of equity to employees, Section 422 of the Internal Revenue Code creates an exception to this general rule.
The grant of equity by the Company to an employee may create a taxable event to the individual receiving the equity grant.
To comply with IRS regulations and achieve maximum tax benefits for recipients, equity incentive awards must be issued by the Company at fair market value (FMV).
Applicable IRS regulations (§ 26 CFR 1.409A-1(iv)) provide a process for determining the FMV of stock issued in connection with option awards. The regulations generally require that FMV be “determined by the reasonable application of a reasonable valuation method.” Determining the fair market value of a share and stock requires careful planning.
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