How UK companies can give US employees stock options

Last updated: 17 June 2024. 

Stock option schemes (or what we tend to call share option schemes in the UK) are a surefire method of uniting teams towards business growth. And they’re not confined by borders. 

For the UK businesses that already operate in the US, or plan to soon, or those with US-based employees, contractors, consultants and others that they want to reward with equity, this one's for you.

While offering options to those in the US involves some unique processes, there are many similarities with how it works in the UK. So let's get to it and explore the steps that you can take to award employee stock options to US taxpayers. 

Why offer stock options to US employees?

Offering stock options to American employees confers the same benefits as rewarding your home team.

Employee ownership strategies offer an effective means to glue teams together and unite them towards the common goal of growth - that's super-important when working with remote team members from different countries.

By offering options as part of a compensation package, employees and team members can benefit from a future uplift in the business’s value. Plus, share schemes in the US offer tax advantages like in the UK, further boosting their appeal. 

Types of stock options for US employees

There are two broad categories of stock options in the US. These are analogous to what we have here in the UK, so there are (luckily) a lot of familiar concepts here.

1. Incentive Stock Options (ISOs)

Incentive Stock Options (ISOs) are a type of tax advantage option broadly similar to the UK’s Enterprise Management Incentive (EMI).

These options are unique in that they can qualify for special tax treatment. If certain conditions are met, ISOs are taxed only when the stocks bought with them are sold.

This is a significant advantage as it allows the employee to potentially pay capital gains tax, often lower than ordinary income tax.

However, ISOs come with several restrictions:

• They can only be granted to employees, not to contractors or consultants.
• The option price cannot be less than the stock's fair market value at the time of grant.
• The total value of stock that can become purchasable in any year cannot exceed $100,000.
• ISOs must be exercised within 10 years of the grant date.
• Employees must exercise their ISOs within 90 days if they leave the company.

2. Non-Qualified Stock Options (NSOs)

Non-qualified Stock Options (NSOs) don’t have the same tax advantages as ISOs and are broadly equivalent to unapproved options in the UK (in that they’re not as tax efficient as HMRC-approved options) though they still need a formal 409A valuation (we'll come onto this shortly). 

NSOs are taxed during exercise based on the difference between the fair market value and the exercise price.

This income is considered supplemental income and taxed accordingly. When the stocks bought with NSOs are eventually sold, the difference between the sale price and the fair market value at the time of exercise is considered a capital gain (or loss) and is taxed as such.

Unlike ISOs, NSOs can be granted to anyone, including employees, consultants, contractors, advisors, and board members. Also, there are no restrictions on the value of the stock that can be purchased in any given year.

The difference between ISOs and NSOs

While ISOs might seem more attractive to employees due to their tax advantages, their restrictions might not suit all companies or employees.

Conversely, NSOs are more flexible but don’t offer the same tax advantages.

A 409A valuation is required for both ISOs and NSOs.

Wait, what's a 409A valuation?

Named after Section 409A of the US Internal Revenue Service (IRS) Code, the 409A valuation is a formal, independent appraisal of a company's common stock's Fair Market Value (FMV).

This differs from the UK, where it’s common for startups to offer options with a nominal exercise price. Moreover, for approved option schemes such as the Enterprise Management Incentive (EMI), the valuation method in the UK is less formal and complex than the US 409A.

Akin to the UK’s HMRC-approved valuations, a 409A valuation is crucial for determining the price at which businesses can offer stock options to employees.

IRS-introduced Section 409A regulations aim to prevent the underpricing of stock options, ensuring tax transparency and fairness.

Moreover, a legitimate 409A valuation protects stock option recipients, granting the company 'safe harbor' status. Therefore, if an IRS inquiry arises, the burden falls on the IRS to uncover any discrepancies in the valuation.

When do I need a 409A valuation?

A UK company granting any type of stock options to US taxpayers requires a 409A valuation. This need extends beyond just US employees, including contractors, consultants, and subsidiaries based in the US.

The valuation ensures compliance with IRS regulations by ascertaining the FMV of the company's common stock when the options are granted.

Conducting a 409A valuation

Although not a legal requirement, a 409A valuation should ideally be undertaken by a third-party appraiser. This protects the business in the event of a dispute from the IRS.

The valuation process involves gathering relevant company information, conducting a comprehensive analysis to determine the FMV of the company's common stock, and generating a detailed valuation report encapsulating the entire process.

We can conduct 409A valuations for our customers. 

Cost of a 409A valuation

The cost of a 409A valuation varies but is often quoted as somewhere between $2,000 and $5,000.

To simplify the process of obtaining an IRS-compliant valuation for issuing US options, we now offer 409A valuations for a fraction of the cost.

How to give US employees stock options

Here’s a step-by-step guide to offering US employees stock options as a UK business.

Again, there are many familiar concepts here compared to UK options schemes, which is excellent news. However, legal nuances are inevitable, particularly when dealing with the stricter ISO.

1. Board and shareholder approval

The board of directors need to adopt and agree to a share plan – this is the framework for US option grants.

Since a non-US company's standard equity plan won’t satisfy US requirements, they typically have to devise a 'sub-plan' or a supplementary plan, designed to align with US rules concerning ISOs and NSOs.

This sub-plan is added to the company's primary equity plan that encompasses all employees, ensuring those in the US are awarded options under the regulations of both the parent plan and the sub-plan. In case of any contradiction, the sub-plan terms would take precedence.

Furthermore, within one year of adoption, the shareholders need to approve the share plan, the US sub-plan, and a limit on the number of shares that can be issued upon exercise of ISOs.

2. 409A valuation

As mentioned, to prevent adverse tax implications under Section 409A of the US tax code, the exercise price of each option should not be less than the FMV of the company's ordinary shares at the time of the grant.

3. Compliance with US securities law

Before granting options in the US, a company should determine whether any filings or notifications are required in the US state where each option recipient resides. Many states require a simple filing, and non-compliance can result in penalties.

At the federal level, companies often use Rule 701 under the US Securities Act of 1933 to establish an exemption for option grants.

4. Grant process and documentation

The board should formally approve the options. The date of this approval will be the grant date.

This grant approval should include specifics such as the recipient's name, the number of shares subject to the option, whether the option is an ISO or a non-qualified option, the exercise price, vesting terms, whether the option can be exercised over unvested shares, and the maximum term of the option.

Keep in mind that the option recipient must be actively employed at the time of the grant – an option can’t be granted in anticipation of a future start date.

Next steps

One of the primary advantages of any share scheme is that it motivates team members and boosts talent acquisition and retention, no matter where employees or team members are based.

However, the task of managing share schemes has always been a tricky one – until Vestd that is!

Our intuitive platform makes issuing options, including for overseas employees, simple. And we now offer customers the 409A valuations they may need too.

Schedule a free consultation with one of our share scheme specialists today to learn more. 

Talk to an expert