When it comes to compensating an employee with a grant of equity, it is not a perfect world if you consider the impact of taxation. A perfect world when granting equity compensation from a tax perspective would include at least the following:

• At the grant date, and as the grant vests, the employee receives no taxable income or gain;
• Upon a change in control, the employee receives the full value of the equity granted (for example, there’s no strike price or participation threshold subtracted from the proceeds);
• The proceeds received are taxed only upon a change in control, which is when the employer company is acquired, and the shareholders can cash out their equity for dollars;
• The entire payout is long-term capital gain to the employee; and
• The employer can deduct the entire amount of the payout to the employee.

Reproduced with permission from Tax Management Memorandum, 63 TMM 18, 08/29/2022. Copyright 2022 by The Bureau of National Affairs, Inc. (800-372-1033) http://www.bna.com