Anthony points to a good overview on equity-based compensation. Motivation issues aside, such plans are also a key means to attract and keep top talent when you might not otherwise have the means (i.e., an early stage startup).
The article discusses the three primary forms of equity - Incentive Stock Options (ISOs), Non-qualified Options (NQOs), and a stock bonus plan.
ISOs are preferable because of the tax treatment for the recipient, but there are stricter requirements in issuing them. A brief matrix outlining the tax implications of ISOs and NQOs is below.
|Event||ISO - Tax to Employee||ISO - Tax to Employer||NQO - Tax to Employee||NQO - Tax to Employer|
|Grant||None||None||None (if close to FMV)||None|
|Sale of Stock||Capital gains above exercise tax||None||Complicated (if held for 2 years, capital gains only)||None|
As I briefly discussed with regard to the options scandals, the goal is to postpone and potentially lower the tax to the recipient.