Tax Implications of Single-Trigger vs. Double-Trigger Vesting: What Employees Need to Know
Let’s talk about your stock benefits. Companies use a long-term bonus plan to keep their employees motivated and committed. Imagine you get offered shares in your company, but you can’t just grab them and go. Instead, you earn the right to own them gradually over time. It rewards sticking around and contributing to the company’s success. This process is called Vesting, and it’s a way for companies to encourage loyalty and hard work from their employees while giving them a stake in the company’s growth.
By 2023, the National Center for Employee Ownership (NCEO) estimates that there are approximately 6,500 employee stock ownership plans (ESOPs) with nearly 14 million participants. Since the start of the 21st century, the number of plans has decreased while the number of participants has grown. Additionally, there are over 4,000 profit-sharing plans and, to a lesser extent, stock bonus plans that are heavily invested in company stock and share many similarities with ESOPs.
When considering stock options or Restricted Stock Units (RSUs), vesting occurs through Single- or Double-Trigger vesting. Single-trigger acceleration involves the immediate Vesting of stock if a specific event, like a change of control, occurs. Double-trigger acceleration requires two events, often a change of control and subsequent termination, for stock vesting to accelerate.
What is Single and Double Trigger Vesting?
Vesting describes how employees gain ownership of their shares over time. Acceleration provisions ensure that employees receive their equity in certain circumstances, usually during a significant change in the company’s ownership or structure.
Single Trigger Acceleration
Imagine you work for a startup and have been granted stock options as compensation. These options typically come with a vesting schedule, meaning you can only fully own them after a certain period, often four years. Now, let’s say another company buys your startup. If your stock options have a single trigger acceleration, the acquisition alone can cause your remaining unvested shares to accelerate, meaning they vest immediately. This provision rewards your loyalty and contribution to the company, ensuring you benefit from its success even if it changes hands.
Double Trigger Acceleration
Now, consider a scenario where your startup is acquired. With double trigger acceleration, the story unfolds a bit differently. The acquisition is the first trigger, but your shares don’t automatically vest. Instead, there’s a second condition. If your employment is terminated within a specified period (often a year), and it’s not due to your wrongdoing, the double trigger is activated. This means your remaining unvested shares accelerate, and you gain ownership. The double trigger adds an extra layer of protection, encouraging you to stick around during the transition period after a change in control.
A single trigger occurs on a “single event.” If someone buys the company, you receive your shares. Double trigger, on the other hand, is a two-step condition: The company changes hands, and then, if you meet specific conditions, your shares accelerate their vesting upon termination. Both mechanisms ensure employees receive rewards for their hard work and commitment, especially during significant company structure changes. They align employees’ interests with the company’s success and stability.
What are the tax implications for the employee to consider?
Understanding the tax implications of single — and double-trigger vesting is important from an employee’s perspective when using equity compensation. These vesting structures help determine when and how employees will have a tax impact on the value of their equity awards.
Taxation Timing
In a single-trigger vesting scenario, employees may face immediate taxation on the value of the vested equity.
Such events as acquisitions often tie the timing of taxation to their respective dates.
Ordinary Income Tax
Typically, tax authorities consider the difference between the fair market value (FMV) of vested equity and the exercise price (if any) as ordinary earnings, subject to standard income tax rates.
Capital Gains Tax
Any future gains from selling the vested equity would be subject to capital gains tax.
The holding period for determining whether the gain is short-term or long-term starts from the date of the triggering event.
Withholding Taxes
Employers usually must withhold taxes on the ordinary income employees recognize upon vesting.
Employees may need to consider the tax implications of the immediate withholding on their cash flow.
Example:
Consider an employee with stock options at a grant price of $10 per share. When single trigger vesting is activated, the company’s stock has a fair market value of $30 per share. The employee holds 1,000 unvested shares.
Ordinary Income Calculation:
Ordinary Income = (FMV at vesting — Grant Price) * Number of Vested Shares
Ordinary Income = ($30 — $10) * 1,000 = $20,000
Tax Withholding:
If the withholding rate is, for example, 25%, the employer would withhold $5,000 for taxes.
Total Taxable Income:
The employee must report $20,000 as ordinary income on their tax return.
Future Capital Gains:
If the employee sells the shares later at $40 per share, the capital gain would be ($40 — $30) * 1,000 = $10,000.
Capital Gains Tax:
The capital gains tax would apply to the $10,000 gain, and the rate would depend on the holding period.
Double Trigger Vesting — Tax Considerations
First Trigger — Change of Control
The first trigger, a change of control (e.g., acquisition of the company), initiates the vesting acceleration but does not immediately trigger taxation.
Second Trigger — Termination of Employment
The second trigger, the termination of employment following the change of control, completes the vesting process.
Ordinary Income Tax
Like single trigger vesting, tax authorities treat the distinction between the fair market value (FMV) of vested equity and the exercise price (if any) as ordinary income.
Tax authorities generally tie the timing of taxation to the date of the termination of employment.
Capital Gains Tax
Any future gains from selling the vested equity would be subject to capital gains tax.
The holding period for determining whether the gain is short-term or long-term starts from the date of the second trigger (termination of employment).
Example:
An employee has stock options with a grant price of $10 per share, and the fair market value of the company’s stock at the time of acquisition (first trigger) is $30 per share. The employee has 1,000 unvested shares. The second trigger, termination of employment, occurs three months after the acquisition.
First Trigger — Change of Control
There are no immediate tax consequences.
Second Trigger — Termination of Employment
Ordinary Income = (FMV at termination — Grant Price) * Number of Vested Shares
Ordinary Income = ($30 — $10) * 1,000 = $20,000
Tax Withholding
The employer withholds taxes on the $20,000 of ordinary income.
Total Taxable Income
The employee reports $20,000 as ordinary income on their tax return.
Future Capital Gains
If the employee sells the shares later at $40 per share, the capital gain would be ($40 — $30) * 1,000 = $10,000.
Capital Gains Tax
The capital gains tax would apply to the $10,000 gain, and the rate would depend on the holding period.
It’s crucial to note that tax laws and regulations can vary, and the specific treatment of single and double-trigger vesting may be subject to change. Therefore, employees and employers should consult with legal advisors or tax practitioners to ensure compliance with current tax laws and understand the implications of these accelerations.
Create your Vesting Schedule with Eqvista!
Employee Stock vesting benefits both the company and the employees. You can set up a basic vesting schedule using an Excel sheet. However, maintaining various vesting schedules can become complex as the company expands and hires employees across different levels.
Eqvista provides expert support in creating, tracking, and managing your company’s vesting plans for all your employees. We offer options for Time-based, performance-based, and hybrid vesting. Contact us to know more.
