How do Stock Appreciaition Awards Work?
When an SAA is granted, the employee is awarded a specified number of phantom stock units. These units don't represent actual ownership of the company's stock but track its performance. The value of the SAA appreciates as the stock price increases, and it depreciates if the stock price decreases.
Vesting Period: SAAs typically have a vesting period, which is the period an employee must remain with the company before they become entitled to the award. Vesting can occur all at once or gradually over a set period.
Payout: Once the SAA has vested and the performance period has ended, the employee receives a payout based on the difference between the stock price at the grant date and the stock price at the vesting date. If the stock price has increased, the employee receives a cash payment equal to the appreciation multiplied by the number of units. If the stock price has decreased, there's no payout.
Taxation of Stock Appreciation Awards:
1. During the Vesting Period: SAAs are not taxable until the vesting period ends.
2. At Vesting: When an SAA vests, employees are taxed on the difference between the stock's fair market value at vesting and the grant price (if any). This is treated as ordinary income.
3. After Vesting: If an employee decides to sell the actual shares of stock received after vesting, they will be subject to capital gains tax on the difference between the sale price and the vesting price.
Stock Appreciation Awards vs. Stock Options:
While both SAAs and stock options are equity-based compensation tools, they have crucial differences:
- SAAs provide employees with a cash payment based on the stock's appreciation, whereas stock options give employees the right to buy company stock at a set price in the future.
- SAAs are taxed at vesting as ordinary income, while stock options are taxed as capital gains when exercised.
- SAAs have no exercise price and don't require any upfront investment from the employee, while stock options typically have an exercise price that the employee must pay to acquire the stock.
Whether SAAs are beneficial depends on the individual's circumstances and the performance of the company's stock. They provide employees with a potential for future financial gains without the immediate financial outlay required by stock options.