Are you thinking of issuing Employee Stock Options (ESO) to reinforce your hiring strategy to attract top talent? Not a bad idea, given the job market

Are you thinking of issuing Employee Stock Options (ESO) to reinforce your hiring strategy to attract top talent? Not a bad idea, given the job market's crunch, as this employee compensation method can benefit bootstrap companies and amount a lot for employees. However, compliance is a must to issue ESOs and take advantage of all it has to offer, including a timely 409a valuation.?

409a Valuation

A 409a valuation is an appraisal of the company's common stock done by an independent party. The company's common stock is reserved for the founders and employees of the company, and businesses often need to commission a third-party appraisal to base the purchase price on fair market value (FMV) of the company's common stock that employees can buy to include ESO in the compensation package.?

How 409a valuation impacts stock options

Stock option pricing must comply with Internal Revenue Service guidelines before a company may issue them. The 409A Valuation will need to be completed by the corporation for this to happen. Deferred compensation is subject to the rules of Internal Tax Code Section 409A. Specific stock options, however, meet the criteria for "stock rights" and are thus exempt from being treated as "deferred compensation" under section 409A.

Nevertheless, the circumstances necessary to qualify for the exclusion are unmet. In that case, IRS will consider the stock options deferred compensation under section 409A and will be required to comply with section 409A or face the penalties for failing to do so.

Penalties for non-compliance?

ESOs offer certain tax benefits to both employees and employers. However, one can only benefit from them if one complies with the government. A 409a valuation allows your business to establish a safe harbor where IRS presumes your equity is priced "reasonably" and avoids related penalties. However, the 409a safe harbor provision will only apply if you do not adequately value the firm before granting these options. The employees and stockholders would be responsible for the following if IRS imposed sanctions:

1. Paying taxes on all deferred compensation in the current year and years before.?
2. Any deferred compensation will be subject to an extra 20% tax.
3. Interest accrued on the adjusted taxable amount.

Now that you understand the penalties for violation of 409a compliance, let's go into compensation using stock options in detail.?

Stock Options and Compensation?

Several organizations utilize ESOs (employee stock options) as equity remuneration for their employees and leaders. The firm sells derivative options rather than the shares themselves. Employees are granted the right, like with call options, to acquire firm shares at a specific price and within a given time frame. The corporation prepares an employee stock options agreement that details all of the ESO's parameters.

Types of stock options

Two types of stock options can be issued and affect how they are treated by IRS and taxed. These two types of ESOs are:

• Incentive Stock Options (ISOs) - Often granted to the company's upper echelons of management, these options are also referred to as qualified or statutory stock options. The IRS often gives them a break by classifying option earnings as long-term capital gains.
• Non-qualified stock options (NSOs) -? Employees at various levels of the organization and outside consultants and board members are eligible to receive these. Gains from these "non-statutory stock options" are treated as regular income for tax purposes.

How the current economic climate affects employee compensation?

Although the tech, banking, and media industries have shed tens of thousands of employees recently, the national unemployment rates are historically low, and there are millions more job vacancies than qualified applicants. The pace of hiring has consistently outperformed the turnover rate, which suggests that the job market is also getting tighter by the day. Companies must factor in compensation increases to compete for and keep the finest workers in light of a restricted job market and record-high inflation.?

Some companies are going over and above by instituting bonuses that account for modifying their pay plans to include annual wage evaluations. Setting pay and benefits is one of many responsibilities of running a company with employees.?

In an increasingly interconnected global market, where companies can find top talent anywhere globally, stock options may help companies advance and establish a strong team. Stock options increase job satisfaction and financial well-being by giving workers a stake in the company's growth and success and allowing them to benefit financially from the company's success.

How can Eqvista help?

As we stated in the beginning, IRS mandates before a corporation may offer a stock option, it must follow the appropriate 409A valuation processes. A proper and timely 409A valuation is essential, and it implies that you need to identify not only a company that can execute your Valuation but also a company that can provide you with safe harbor status by way of a 409a valuation.

At Eqvista, we offer 409A Valuation keeping all the compliance regulations in mind to help your business acquire safe harbor status. We also provide a top-notch cap table program where your company's stock may be maintained and valued for 409a purposes in one convenient spot.