A private California corporation granted stock options to its executive team that were exercised on the same day as grant (83bs have been filed), with a 4-year vesting period. The exercise was paid for with a promissory note. Does this transaction eliminate the need to record compensation expense and APIC-Options (and also the deferred
Stock Option Exercise on the Grant Date
Answers
Let me ask a clarifying question...the options were granted at-the-money? The stock, not the option, is what vests? So you *essentially* sold the stock to the exec's in question at market value? If you can treat it that way, I believe you're in the clear....however;
Even an "at the money" option has value; I believe that the grant in and of itself is compensation, and would have to have been treated as such at the time of grant.
I'm *reasonably* sure that the proper way to have done this is to issue an SPR for an at-market purchase (or something similar) that doesn't have intrinsic value. I'd be hesitant to say that this (as described) isn't compensation expense.
The other piece to this is the promissory note. First, it is a related-party transaction loaning money to Execs, and I'd consult a tax expert to make sure that this doesn't fall afoul of deferred comp and other rules. Second, depending on the terms of the promissory note, it could look very artificial, in as much as the transaction could be said not to have ever happened. Again, that would need to be cleared with a tax attorney as I can see it going wrong.
1
Thanks Keith! Yes grant price=fmv=exercise price. Private company. The stock was sold at market value. Does that negate the "compensation" component of the options since they were immediately purchased as restricted stock?
Actually, you do not escape expense this way, you value the shares in the same way, record a Deferred Tax Liability for the total expense and then book the expense and write off the DTL as the expense is recorded. I am NOT an expert on the JEs for this, but I do know for certain that early exercise does not remove the need to expense the options.
From the PwC "Guide to
If an employee makes an IRC Section 83(b) election, the company measures the
value of the award on the grant date and records a deferred tax liability for the
value of the award multiplied by the applicable tax rate, reflecting the fact that the
company has received the tax deduction from the award before any compensation cost has been recognized for financial reporting purposes. In this case, the deferred tax liability offsets the current tax benefit the company is entitled to by virtue of the employee’s IRC Section 83(b) election. As the company recognizes book compensation cost over the requisite service period, the deferred tax liability will be reduced (in lieu of establishing a deferred tax asset since the tax deduction has already occurred). If an IRC Section 83(b) election is made by an employee for an equity-classified award, there will not be a windfall or shortfall upon settlement because the tax deduction equaled the grant-date fair value. If, however, an IRC Section 83(b) election is made for liability-classified restricted stock, a windfall or shortfall likely would occur at settlement because the tax deduction is measured at the grant date, whereas the book compensation cost for a liability award is remeasured through the settlement date.
This section actually refers to restricted stock, but the same applies to options.
2
Thanks Elizabeth! For clarification purposes, what event are you referring to when you say "settlement date"? Yes this is restricted stock.
I don't see a way to reply to the reply from 1/7, so I'm replying to my own answer:
Settlement is the event that ends the life of the grant. For options, exercise (though it can also be expiration) for Restricted Stock (not RSUs) it is the vesting. (For RSUs it is the release of the shares, but that is not relevant here since no 83(b) election can be filed on RSUs.)
Settlement can also be thought of as the event that provides the tax deduction to the company OR eliminates the possibility of a future tax deduction (like option expiration). The windfall/shortfall calculation is performed at settlement.
FORFEITURE is different, however, that is cancellation pre-vest when expense is reversed for the grant and generally shortfall/windfall calculations are not performed. Likewise for an option exercised before vest, if the grant were cancelled before vest, the Deferred Tax Liability would also be reversed.
How can you exercise an unvested option?
As already mentioned, you book the compensation expense for granting the option, regardless of when exercised. Since grantees couldn't fully exercise until vested, this sounds like an issuance of restricted stock, not a stock option, although then I'm not sure why 83(b) election would be made.
Depending on what was issued, you could avoid comp expense/APIC. I would recommend googling "restricted share units" "form 10-k - investor relations" to see some financial statement examples if this is not an actual stock option.
3
Yes it is restricted stock. Why do you think an 83(b) is not required?
Exercising unvested stock options is actually fairly common in private companies, especially in the Silicon Valley.
I'm always relieved to find when companies don't do it, since it complicates taxation and tax accounting considerably and many (most? all?) systems that provide accounting for stock plans / stock options do not support "early exercise" correctly for accounting at least.
You absolutely can allow "exercise before vest" or "early exercise" on stock options. See Section 2.4 of "The Stock Options Book" (13th edition) which covers 83(b) elections on options exercised prior to vesting. But one caution, the elections don't "work" on ordinary income for ISOs - you can file them, but you don't get the improved tax consequences. It may be beneficial for AMT, however.
If I understand the situation correctly, you have issued restricted stock to employees at FMV on grant date. This eliminates any income to the employee (and tax deduction to the employer) if 83(b) elections are made timely. Since there is no compensaton expense to the corporation under this scenario, I don't believe their is a deferred tax liability as Elizabeth lays out above from the PWC Guide (again since there isn't any compensation expense under ABP 25 or 123R). Again, my interpretation might be off, but I believe I am correct on that. Good luck.. a call to your auditors also will be helpful.
Ted, I think the clarifying point here is that these were done as options, not SPRs. As Jeff noted, the grant is the trigger for the expense, regardless of exercise timing.
I think Jeff's suggestion is the right one: sell restricted stock at value directly, don't mess with options or 83(b)s and you have a much cleaner deal (except the loan...where you need to be careful).
Sorry, but I believe this was done as restricted stock grants... please see the response to Jeff Fisher. Otherwise the situation that is being described doesn't make any sense. (An option you exercise for stock that is restricted?)
The most common scenario I have seen is a grant of restricted stock with the strike price at FMV. The loan is made from the company to pay the exercise cost and the restrictions lapse over 4 years. You would file the 83(b) to avoid picking up income as the grantee as the restriction lapses. There is some goofiness that occurs with the loan whether it is forgiven by the company or paid back by the employee, but I don't believe this changes the FAS123r accounting on it.
1
You absolutely can allow "exercise before vest" or "early exercise" on stock options. See Section 2.4 of "The Stock Options Book" (13th edition) which covers 83(b) elections on options exercised prior to vesting. But one caution, the elections don't "work" on ordinary income for ISOs - you can file them, but you don't get the improved tax consequences. It may be beneficial for AMT, however.
Filed Under:
FP&A