Contributor to South-Western Federal Taxation Series by D. Larry Crumbley

Stock-based compensation, e.g. stock options and option award, is the most significant component of compensation for the largest public companies. Companies also offer these types benefits to rank-and file employees. Jack Ciesielki found that the average salary and bonus was 14.5%, while pension and deferred compensation was 4.5%, and equity-type compensation was around 59% for large-company executives.
Elon Musk, CEO of Tesla, Inc., was the highest-paid CEO in 2018. He received $513 million in option awards. Tim Cook, CEO of Apple, Inc., received $126 million in stock awards, which is $141 million of his $141million compensation. Nikesh Arora (Palo Alto Networks), was the fifth highest-paid CEO. He had $72 million in option and $39 million stock awards from a $130million package. Stock awards are often contingent upon performance and can be reduced if they are not met.
Stock-based compensation motivates employees and executives to perform at higher levels, retain employees, and recruit new talent. Stock option and option awards reduce the employer’s after tax cost and maximize an employee’s benefits. Executives get benefits when company stock prices rise and don’t lose if they fall.

Types of stock options
There are two main types of stock options: non-qualified stock options and incentive stock options. A corporation gives options to employees to purchase stock at a specified price, instead of paying cash or corporate stock compensation. Publicly traded companies use stock option plans more often than closely held companies. This is due to the difficulty of determining the stock value of a company that isn’t publicly traded. This is a practical requirement to avoid the 20% excise taxes under SS 409A.
Nonqualified stock options (NQSOs), on the other hand, are more flexible than qualified incentive stock options. An example is that an NQSO’s holding period is shorter than an ISO. The option price for an NQSO cannot be lower than the fair market value at the time it is granted. An NQSO is a deduction that the employer can use to lower the NQSO’s cost. This tax savings may be passed on to the employee by the employer in the form a cash payment. Employer and employee may both be better off combining NQSOs and additional cash payments, rather than using ISOs. Stock options are almost always nonqualified stock options.

Comparing Stock Options
Below is a comparison between incentive stock options and other non-qualified stock options.

Ideas for Class Assignments
Students should determine the 20 highest-paid CEOs in 2019 to calculate their stock-based compensation percentage. Calculate the stock-based percentage.
Students should review IRC SS409A.
Examine and define phantom stock.

References:
Jack Ciesielski. “2016 S&P500 Executive Pay: Why & How Much It Matters for Shareholders,” The Analyst’s Accounting Observer. Vol. 26, No. 9 (August 25, 2017).
Melin, A. et al., “A 300% Surge Makes Pot CEO No. Bloomberg, May 17, 2019, 2 in Pay Ranking After Elon Musk,” Melin, A. et al.
IRC SSSS 422B, 83, and 409A.
SSSS 1.421-6(c), (1d) and (1e).

SWFT Chapters
Chapter 19 – SWFT Individuals
SWFT Comprehensive: Chapter 7

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