Stock Appreciation Rights: 50% Boost to Employee Compensation

Understanding Stock Appreciation Rights (SARs)

Stock appreciation rights (SARs) are a form of employee compensation that allow recipients to benefit from the appreciation in a company's stock without having to purchase the shares themselves. SARs are typically granted to executives and key employees as a way to incentivize them and align their interests with those of the company.

Types of SARs

There are two main types of SARs:

• Non-qualified SARs: These SARs are taxed as ordinary income when they are exercised, and they are not eligible for preferential capital gains treatment.
• Incentive SARs (ISOs): These SARs are taxed as capital gains when they are exercised, and they are eligible for preferential capital gains treatment if certain requirements are met.

How SARs Work

SARs are typically granted for a specific number of shares of a company's stock. The value of the SARs is based on the difference between the price of the stock on the date the SARs are granted and the price of the stock on the date they are exercised.

For example, if an employee is granted 1,000 SARs and the stock price on the date of grant is $10 per share, the employee will receive $10,000 in compensation if the stock price rises to $20 per share when the SARs are exercised.

Tax Treatment of SARs

The tax treatment of SARs depends on the type of SARs granted. Non-qualified SARs are taxed as ordinary income when they are exercised, and they are not eligible for preferential capital gains treatment. Incentive SARs (ISOs) are taxed as capital gains when they are exercised, and they are eligible for preferential capital gains treatment if certain requirements are met.

Benefits of SARs

SARs can provide a number of benefits to both employees and companies:

Benefits to employees:

• SARs can provide employees with a significant financial incentive to work hard and contribute to the success of the company.
• SARs can help employees to diversify their investment portfolios.
• SARs can be used to defer income taxes until the shares are sold.

Benefits to companies:

• SARs can be used to attract and retain key employees.
• SARs can align the interests of employees with those of the company.
• SARs can be used to motivate employees to work harder and perform better.

Risks of SARs

SARs also come with some risks, including:

• The value of SARs is dependent on the price of the company's stock, which can fluctuate significantly.
• Employees may have to pay taxes on the gain from SARs even if they do not sell the underlying shares.
• SARs may not be as valuable as other forms of compensation, such as stock options or restricted stock units (RSUs).

SARs vs. Stock Options

SARs and stock options are both forms of employee compensation that allow recipients to benefit from the appreciation in a company's stock. However, there are some key differences between SARs and stock options:

• Tax treatment: SARs are taxed as ordinary income when they are exercised, while stock options are taxed as capital gains when they are exercised.
• Exercising the rights: SARs must be exercised within a certain time period, while stock options can be exercised at any time.
• Risk: The value of SARs is dependent on the price of the company's stock, while the value of stock options is dependent on the price of the company's stock and the strike price of the options.

Pros and Cons of SARs

Pros:

• Can incentivize employees to perform better
• Can align employee interests with company goals
• Can be used to attract and retain key employees

Cons:

• Can be complex to administer
• Can be expensive for companies
• Can be risky for employees if the company's stock price declines

Conclusion

SARs can be a valuable tool for companies to attract and retain key employees and align their interests with those of the company. However, it is important to understand the tax implications and risks associated with SARs before making a decision about whether or not to grant them.

Additional Resources

• IRS Publication 525: Taxable and Nontaxable Income
• NASAA: Stock Appreciation Rights
• Mercer: Stock Appreciation Rights (SARs)

Questions to Ask Yourself About SARs

• Are SARs a good fit for my company?
• How should SARs be structured to meet my company's needs?
• What are the tax implications of SARs for my employees?
• How can I communicate the value of SARs to my employees?

Tables

Table 1: Comparison of SARs and Stock Options

Table 2: Benefits of SARs

Table 3: Risks of SARs

Table 4: Questions to Ask Yourself About SARs