Accounting Aspects of Capital Structures and Stock Based Compensation

Transcription

1 Accounting Aspects of Capital Structures and Stock Based Compensation 1

2 Accounting Aspects Agenda Equity Instruments Accounting for Common Stock Accounting for Preferred Stock Accounting for Debt Accounting for Options and Warrants Capitalization Table 2

3 Accounting for Common Stock Accounting is generally straightforward Always treated as equity If issued for services, then record at value of the service If issued for compensation to employees, then record at fair value If restricted, record compensation over vesting period If a note is issued in exchange for common stock, then record note in equity too 3

4 Accounting for Preferred Stock Accounting can be very complex Preferred stock has preferences: Redemption features Conversion features Anti- dilution protection Liquidation order Dividends paid 1 st (cumulative or non- cumulative) Issued with warrants (discussed later) Treated as equity or liability, depending on terms Costs incurred to 3 rd parties applied against proceeds 4

5 Accounting for Preferred Stock (continued) If mandatorily redeemable, then record at fair value as a liability Mandatorily redeemable if it speciqies a required repayment date Record change in fair value through income statement each reporting period If contingently redeemable, then record at initial value in equity No adjustments to amount recorded initially Reclassify to a liability once contingency is resolved and record at fair value 5

6 Accounting for Debt Accounting can be complex Conversion features Anti- dilution protection Issued with warrants (discussed later) Zero interest rate Always treated as liability Costs incurred are capitalized Paid to 3 rd parties debt issuance costs as an asset and amortized Paid to debt holder debt discount and accreted 6

7 Accounting for Debt (continued) If convertible, then assess accounting for conversion feature Is it a derivative requiring bifurcating and recording as a liability? If no, is there a beneqicial conversion feature (BCF) to record? If there is a BCF, treat as a debt discount and paid- in capital (equity) and accrete to interest over term of debt. Also, applies to preferred stock Assess conversion into common stock to determine if a derivative BCF is applied against retained earnings and record paid- in capital immediately 7

8 Accounting for Options Accounting generally straightforward. Almost always equity Generally issued to employees, board members and consultants. Generally a vesting period for rights to exercise options (1-4 years) Record at fair value as equity based on a model (Black- Scholes or lattice) Estimates for expected term and forfeiture rates Record compensation over vesting period Complicated if performance or market based vesting provisions Additional complexity if issued to consultant and include vesting terms 8

9 Accounting for Warrants Accounting can be complex. Generally issued to underwriters/brokers and attorneys. Generally, fully vested upon issuance. If issued with preferred stock or debt, then assign proceeds value to preferred stock or debt and warrant proportionately based on fair value of each. Preferred stock follow assessment described in previous section Debt record as a debt discount and accrete as interest expense 9

10 Accounting for Warrants Record at fair value as equity or liability Fair value is based on model (Black- Scholes or lattice) If equity, no subsequent adjustments to value If liability, record at fair value each reporting period Warrants generally a liability for the following: Includes anti- dilution protection feature Exercisable for redeemable (mandatory or contingent) preferred stock 10

11 Capitalization Table Have a detailed listing of all equity instruments (i.e., a capitalization table), including impact on common stock for: conversion debt or preferred stock exercise of options and warrants Have formal signed agreements for all equity instruments, including: family and friends consultants Employees SigniQicantly reduces litigation and claims exposures 11

12 Questions? Thank you! 12

13 Tax Aspects of Stock Based Compensation 13

14 Tax Aspects Agenda Income Tax Treatment of Stock Options Brief Summary of Tax Aspects of ASC 718 (formerly FAS 123R) 14

15 Income Tax Treatment of Stock Options 15

16 Types of Equity Compensation Stock options Restricted stock Stock purchase plans 16

17 Stock Options Allows holder to purchase stock in the future at a stipulated price (option price) Two types for tax purposes Incentive stock options (ISOs) Meet the requirements under Section 422 Shareholder approval of the plan Option price FMV on the date of grant Nontransferable Can only be granted to employees 17

18 Stock Options (cont.) NonqualiQied stock options (NSOs) Any option which is not an ISO Can be granted to employees and nonemployees Flexibility in setting option price at less than FMV on date of grant (beware of 409A) 18

19 Tax Treatment of Stock Options Tax Treatment of Grant Tax Treatment at Exercise Tax Treatment at Sale 19

20 ISOs Tax Treatment at Grant No taxable income to the employee No deduction to the employer 20

21 ISOs Tax Treatment at Exercise No taxable income for regular tax Adjustment for alternative minimum tax (AMT) Difference between FMV at Exercise and Exercise Price ( Spread ) May generate an AMT Credit Complicated Calculation Can Reduce Regular Tax Liability In Future 21

22 ISOs Tax Treatment at Sale Capital Gains on Qualifying Dispositions Must hold stock for the later of 1) 2 years from the date of grant and 2) 1 year from the date of exercise Sale Price less Exercise Price is Long- Term Capital Gain No deduction to employer 22

23 ISOs Disqualifying Dispositions Do no Meet Holding Period Requirements Compensation (W- 2) Income Compensation is Lesser of: Gain Realized; or Spread at Date of Exercise Any Remaining Gain is Capital Gain Employer deduction equal to ordinary income recognized by employee 23

24 NSOs Tax Treatment at Grant No taxable income to employee Assumes no readily ascertainable FMV No deduction to the employer 24

25 NSOs Tax Treatment at Exercise Difference between FMV of stock and exercise price is ordinary income For employees, treated at W- 2 wages Subject to income and employment tax withholdings If independent contractor, report on 1099 Employer receives tax deduction in the amount, and at the time, of Individual s gain upon exercise 25

26 NSOs Tax Treatment at Sale Difference between sales price and FMV on date of exercise is capital gain Long- term vs. short- term determination will depend on holding period from date of exercise See capital gain rate schedule No deduction to employer 26

27 Restricted Stock Plans Company issues stock to employees (or nonemployees) Shares are nontransferable until vested Company typically has the right to repurchase (at the original issue price) any unvested shares if the individual were to leave 27

28 Tax Treatment of Restricted Stock Plans Tax Treatment at Grant Tax Treatment at Vesting Tax Treatment at Sale 28

29 Restricted Stock Tax Treatment at Grant Most common form of restriction is employer s repurchase right Right to repurchase any unvested shares Substantial risk of forfeiture No taxable income Tax takes a wait and see approach Exception if a Section 83(b) election is made No deduction to employer 29

30 Section 83(b) Election May elect to currently include any spread between FMV and purchase price as taxable income (ordinary) Holding period starts immediately Long- term capital gain purposes Must Qile the election with the IRS within 30 days of receiving the property 30

31 Restricted Stock Tax Treatment at Vesting Spread between FMV at vesting and purchase price is taxable income (ordinary) Holding period begins for long- term capital gain purposes If Section 83(b) election was made, no taxable income is recognized Deduction to employer in the amount (including dividends), and at the time the individual realizes ordinary income 31

32 Restricted Stock Tax Treatment at Sale Difference between sales price and basis is capital gain (or loss) Determination of long- term vs. short- term depends upon holding period 32

33 Employee Stock Purchase Plans (ESPPs or 423 Plans) Employees elect to have amounts withheld from their normal pay At the end of the accumulation period, the Company issues shares to the employees Purchase price is typically set at 85% of the lower of the stock price on the purchase date or the grant date 33

34 ESPPs (cont.) Typically used by public companies Offers employees the ability to purchase shares of the Company at a discount Public market gives the employees the Qlexibility of selling shares when needed Plan has to meet the requirements of Section

35 Tax Treatment of ESPPs Similar Tax Treatment as ISOs No Taxable Income at Grant No Taxable Income at Exercise (Purchase) No AMT Adjustment for Spread Tax Treatment at Sale Qualifying Dispositions Disqualifying Dispositions 35

36 ESPPs Disqualifying Dispositions Same Holding Period as ISOs Ordinary Income is the Lesser of: Gain Realized; or Discount at Date of Grant Any Remaining Gain is Long- Term Capital Gain 36

37 ESPPs Disqualifying Dispositions Do no Meet Holding Period Requirements Difference Between the Fair Market Value at the Purchase Date and the Purchase Price is Ordinary Income Gain Realized on the Sale of Stock less the Ordinary Income Recognized is Capital Gain or Loss Deduction to employer in the amount of ordinary income recognized by employee 37

38 Brief Summary of Tax Aspects of ASC

39 Common ASC 718 Tax Issues ISOs & ESPPs are treated as permanent differences NSO and restricted stock treated as temporary differences DTAs set- up for temporary differences reverse upon exercise of option (vesting of restricted stock), expiration of the option, or forfeiture of the option Other aspects of ASC 718 policy elections 39

40 Questions? Thank you! 40