Introduction A summary of the range of schemes available in the US

Profit Sharing Plans And Eligible Individual Account Plans (EIAP) An EIAP is a form of profit sharing plan which can be designed to permit up to 100% of trust assets to be invested in employer securities.

Broad Stock Options: Incentive Options

There are two types of broad employee stock options that receive special treatment under the Internal Revenue Code: incentive stock options and employee stock purchase plans. There is no recognition of income on option grant or on the exercise of the option under either of these programs for employee ownership. Additionally, if the stock is disposed of after completion of the statutory holding period, any appreciation will be taxed as capital gain.

With an incentive stock option, a company grants the employee an option to purchase stock at some time in the future at a specified price. With an incentive stock option, there are restrictions on how the option is to be structured and when the option stock can be transferred. The employee will exercise the option at some time when the value of the option stock is greater than the exercise price of the option. As the value of the stock increases relative to the option price, the employee has the potential to benefit from the increase in the option stock's value over the option exercise price. The employee does not recognize ordinary income at option grant or exercise (although the spread between the option price and the option stock's fair market value constitutes an item of adjustment for alternative minimum tax purposes), and the company cannot deduct the related compensation expense. The employee is taxed only upon disposition of the option stock. The gain is all capital gain for a qualifying disposition. For a disqualifying disposition, the employee will recognize ordinary income as well as capital gain.

Incentive stock options enable employees to share in the appreciation and the value of the stock, and provide the employer with more flexible arrangements than allowed in a qualified retirement plan. They may be designed so that employees may put their capital at risk or so that employees are given assistance in financing the exercise price through the use of stock and option exercise programs and employee loan programs. Employees are able to realize the compensatory gains on the options while employed, rather than having to wait until termination of employment. Options also provide executives with the opportunity to realise unlimited gains. In addition, the employer can tailor incentive stock options to benefit only those employees whose action may impact the stock's value, which would not be possible in a qualified retirement plan.

From the employer's standpoint, the most important advantage of incentive stock options is that they enable a company to attract and keep talent without draining cash flow by paying high salaries. Incentive stock options should be especially helpful for cash-poor companies with good growth prospects. From the employee's point of view, an employee receiving an incentive stock option recognizes no taxable income upon its receipt or exercise. If the incentive stock option is exercised more than three months after the employee has left the employ of the company granting the option, however, this favourable tax treatment is not available.

Upon a qualifying disposition, the employee recognizes capital gain, measured by the difference between the option price and the sale proceeds. After the Tax Reform Act of 1986, which substantially reduced the progressive nature of the individual taxpayer's rate structure and repealed favorable tax rates for capital gains, the tax advantage realised upon disposition of the stock was reduced. After the Revenue Reconciliation Act of 1993, however, there was a substantial differential between the top marginal tax rates for capital gains at 28% and ordinary income at 39.6%. After tax reforms in 2003, the gap has widened further in many situations in which favourable rates of capital gains tax apply..

ISOs can however have a major disadvantage for the employee because the spread between the purchase and grant price is subject to the AMT (Alternative Minimum Tax). The AMT was enacted to prevent higher-income taxpayers from paying too little tax because they were able to take a variety of tax deductions or exclusions (such as the spread on the exercise of an ISO). It requires that taxpayers who may be subject to the tax calculate what they owe in two ways. First, they figure out how much tax they would owe using the normal tax rules. Then, they add back in to their taxable income certain deductions and exclusions they took when figuring their regular tax and, using this now higher number, calculate the AMT. These "add-backs" are called "preference items" and the spread on an incentive stock option (but not on an NSO - Unqualified Stock Option, see below) is one of these items. For taxable income up to $175,000 or less, the AMT tax rate is 26%; for amounts over this, the rate is 28%. If the AMT is higher, the taxpayer pays that tax instead. If the amount paid under the AMT exceeds what would have been paid under normal tax rules that year, this AMT excess becomes a "minimum tax credit" (MTC) that can be applied in future years when normal taxes exceed the AMT amount.

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