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What’s Equity-Based Compensation and How Does It Work?

Offering equity-based compensation can be tricky, so we break down important equity concepts and the nuances of compensating employees with equity.

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Mar 30, 20212 minutes
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Whether you’re a scrappy startup looking for new ways to incentivize your team, or an established company that’s finally ready to offer equity to your employees, equity-based compensation, or stock-based compensation, is one way to provide more financial benefits to your team, while bolstering company loyalty.

Offering equity-based compensation can be tricky, and involves extensive work to produce agreements as well as report on vesting or grants accurately with the IRS. We’ll do our best to break down what exactly is equity-based compensation and how it works.

What Is Equity-Based Compensation?

Equity-based compensation, according to the IRS, “includes any compensation paid to an employee, director, or independent contractor that is based on the value of specified stock”.

A couple of examples of equity:

  • If an employee exercises a nonqualified stock option and the exercise price is $5 per share and at the time of exercise the fair market value of a share is $10, the employee has taxable income of $5 per share.

  • If an employee is awarded restricted stock and the right to the restricted stock vests, the fair market value of the stock may be taxable income to the employee upon vesting.

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Equity-based compensation is complex. If you are unsure whether or not an employee should be taxed on any such compensation, you should consult your own tax advisor or legal counsel.

Equity-based compensation can also trigger taxable income to employees when equity interests are granted, vested and/or exercised.

Oftentimes, equity-based compensation is redeemable at the employee's or employer's option. Equity-based compensation that is redeemable at the employee's option is considered an employer obligation, and thus a liability while awards that are redeemable at the employer's option are classified as equity.

Is Stock-Based Compensation Different?

Stock and equity are one in the same. Compensating an employee with shares of stock is one way to provide an equity interest in a company.

When an employee receives stock, they receive ownership stake in the company. Compensation, in this case, comes from receiving a share of the profits in the form of dividends and/or stock price growth.

Related Article: How and Why Justworks Compensates our ERG Leads

Compensating Your Team in More Way Than One

If you’re looking for other ways to take care of your team, it’s time to consider what a Professional Employer Organization (PEO) like Justworks can do for your organization. PEOs provides access to quality benefits and a wide variety of rich plans — usually only afforded to large corporations — all at competitive rates. Learn more about Justworks benefits here.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, legal or tax advice. If you have any legal or tax questions regarding this content or related issues, then you should consult with your professional legal or tax advisor.