Employee stock plans: How to maximise incentives and minimise risks

2 November 2021
Employee stock plans are a valuable tool for employers. They’re used across a spectrum of businesses, from start-ups expanding globally to established multinationals. Indeed, they’ve become an integral part of many multinational employers’ remuneration packages, and top talent expects stock incentives to be a part of their compensation packages.

Many employers have moved on from traditional stock-option plans to more innovative approaches such as phantom stock plans. But the underlying principles of the schemes discussed here remain the same: they exist to attract and retain great people.

Available plans

Stock option plans give an employee the right, not the obligation, to purchase company stock at a predetermined price at a future point, either after a specific period of employment or after meeting certain performance conditions. After meeting the vesting conditions, the employee can exercise their right to purchase the stock. The purchase price to the employee under a stock option plan is usually the fair market value at the grant date.

Restricted stock units (RSUs) are units of company stock issued subject to similar vesting restrictions based on achieving continued employment and/or performance conditions. Upon reaching a fixed vesting date, the restrictions on the RSUs are lifted and ownership is transferred to the employee at that time. RSUs generally have no employee cost attached.

Restricted stock plans are similar to RSUs. The main difference is the timing of the transfer of stock ownership to employees. For restricted stock plans, the stock is transferred to employees at the start of the plan, though with restrictions applying to shareholder rights, dividends and more. The restrictions are lifted at the end of the vest period.

Employee stock purchase plans (ESPPs) allow employees to purchase company stock at a discounted price to the stock’s market value. Purchases must be made through payroll deductions during set periods.

Phantom stock plans issue employees hypothetical stock based on the company’s stock price at the time of issuance. The hypothetical stocks are issued in the form of cash payments. Phantom stock plans are common in countries where it is complex to set up and administer a stock plan.

Continued popularity

Stock option plans continue to be a  popular choice with all businesses, but particularly with start-ups and rapidly expanding companies. The plans typically have a staged three- to five-year vest period, which promotes employee retention. In addition, they provide employees with flexibility as to when they can exercise their options, which can result in tax and social security advantages. ESPPs have become increasingly attractive to employers that want to offer short-term incentives to their employees; employers typically offer discounted stock at six-monthly intervals.

Delivering a competitive employee plan and maximising cost efficiency

The best-managed plans are clearly communicated, delivered efficiently and compliant with all applicable regulations. They also incentivise employees, in part by maximising any available tax and/or social security advantages.

Employers can develop a successful plan that suits their needs by obtaining sound advice and conducting proper planning well in advance of plan implementation. Here are some steps to consider when developing a plan.

Inform and incentivise employees. When implementing a stock plan, it is essential to ensure that employees are fully informed of the plan’s term and administrative aspects, along with the potential value of the benefit and any tax and social security implications. For the plan to be a true incentive, employees must firmly grasp the “dollar value” that could end up in their pockets.

Deliver efficiently. A successful stock plan must be delivered effectively and efficiently. Employers must develop sound processes and procedures to manage employee participation, including monitoring vesting criteria and timelines, stock issuance, payroll processing and employer compliance obligations.

Maximise tax and social security advantages. Employers around the world have many opportunities to establish employee stock plans in a manner that achieves tax and/or social security savings. Those savings can be significant for both the employees and the employer. It is essential to understand local tax and social security advantages before establishing a plan in a new jurisdiction. Many countries have specific qualifying criteria that will dictate how a plan should be structured. In some cases, an employer may want to obtain a variance to the jurisdiction’s standard plan.

It should be emphasised that many countries have recognised tax and social security advantaged arrangements. In Europe, for example, savings are available in Denmark, France, Hungary, Ireland, Slovenia, Sweden and the UK.

Achieve compliance in each country of operation. Employer compliance obligations related to employee stock plans vary considerably by country. Generally speaking, stock-plan tax and social security compliance obligations for the employer are divided into four main categories:

  1. No employer compliance obligations
  2. Compliance obligations extending to payroll withholding only
  3. Compliance obligations extending to off-payroll reporting only
  4. Compliance obligations extending to payroll and off-payroll reporting

It is risky to generalise about tax and social security treatment for employee stock, because as we’ve mentioned each jurisdiction’s rules are distinct. That said, the following treatments are typical for plans that are not part of a recognised tax and/or social security advantaged scheme:

  •  Stock options are taxable and, if appropriate, chargeable to social security when exercised. The gain chargeable is calculated as the spread between fair market value and the paid option price.
  • Restricted stock plans and RSUs are taxable and, if appropriate, chargeable to social security at vest (that is, when the stock is transferred to the employee) and no restrictions apply. The gain chargeable is calculated using the fair market value of the stock moved.
  • ESPPs are taxable and, if appropriate, chargeable to social security at the date the employee purchases any shares at a discount. The gain chargeable is calculated as the value of the discount to fair market value.

Employers must have policies and processes in place to fulfil any compliance obligations. Timing in particular is crucial. The value of gains needs to be processed through payroll for appropriate withholding as soon as possible after the gain arises, preferably no later than through the next available payroll cycle. Where sell-to-settle or net-settle arrangements are in place (that is, when employees are delivered a net amount of shares after taking into account estimated tax or social security liabilities through payroll), the employer must contend with an additional layer of complexity and administration. Failure to comply with local rules can lead to financial penalties and reputational damage, to say nothing of the negative effects on employees.

Given the number of plans available — and the related compliance obligations and tax and social security advantages that vary by country — there is no getting around the fact that developing and implementing a stock plan is complex. But stock plans are increasingly seen as an essential employer benefit in a tightening global talent market. The best way to lower risks and ensure success is to conduct thorough due diligence before deciding on a stock plan with the help of experienced third-party advisors.

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