Definition of Stock Grants
A company can offer an employee a stock grant instead of paying the wages that the employee would normally receive. Stock grants are useful for a startup firm, which may not have the revenue to pay an employee the current market rate for labor. Executives may receive stock grants as compensation to provide an additional performance incentive. Many stock grants give the employee stock options, which provide the employee the right to purchase stock at a specific price.
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Significance
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A stock grant gives an employee an additional incentive to work harder. When an employee receives an hourly wage, or a salary, the employee only has to satisfy the minimum performance requirements of the job to receive income. If the employee receives a stock grant, the employee's earnings depend on how profitable the company is, so the employee will earn more money for performing work that a manager does not require.
Time Frame
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The employee may have to wait several years before receiving the right to purchase stock at a low price. This system, known as vesting, requires the employee to work at the firm for a specific period of time before receiving full compensation. Vesting provides an incentive for the employee to stay at a firm and not switch jobs. It also encourages the employee to make decisions that are good for the company in the long run, since the employee has to wait several years to sell the stock.
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Considerations
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When an employee earns stock options as income, he can either use the option to immediately sell the stock, or use the option to purchase the stock at a low price and hold it. According to Northwestern University, if an employee uses the option to immediately sell the stock, this income is taxed at the employee's normal tax rate on wage income, but if the employee uses the stock option and does not sell the stock for at least a year, the employee can pay the lower capital gains rate.
Benefits
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A federal tax regulation known as Section 83 allows the employee to report income for a stock option grant when the company offers the grant, not when the grant fully vests. This can allow the employee to save money on federal income taxes, because the value of the stock may be higher in the future when the option vests.
Warning
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A stock grant is risky because it makes the employee more dependent on the firm's performance. A company that is struggling still has to pay its employees, and employees have the right to receive wages even if the company is losing money. If an employee receives a stock grant and the company is not profitable, the employee may receive less compensation than the employee would get at a firm that does not offer stock grants.
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