Tax Considerations For Employee Equity Incentive Compensation

For companies seeking to attract and retain key employees, there often comes a time when discussions turn to granting equity-based incentive compensation. Employee equity grants are often done on an individual basis or through a formalized plan. The tax impact of equity incentive compensation on employers and employees differs depending on the type of entity issuing the compensation.

For both C corporations and LLCs taxed as partnerships, there is a tension between the employer and employee regarding the tax character of equity grants: Employers prefer to grant equity taxed as ordinary income, which would result in a deduction on the part of the company, while employees prefer to receive equity that will provide long-term capital gains treatment in whole or in part. Below is a discussion of some common forms of equity compensation for both C corporations and LLCs as well as their tax considerations and practical implications.