Archive for September, 2008



September 23, 2008

Tifanie Jodeh is a contributing author to Inside Film Magazine Online.

Click here to read her articles:




CEO Morris Ruskin Shores Up the Line for Entertainment Globalization

September 22, 2008


September 21, 2008


Paul Battista, Esq

It is common for start-up and established corporations to offer stock to employees and/or independent contractors in exchange for services provided.  Corporate stock provided by a company in exchange for services may take several forms, including:  (1) “incentive stock options” (“ISOs”); (2) “nonstatutory stock options” (“NSOs”); or (3) “restricted stock”.  Each form, however, is accompanied by different tax consequences.

Incentive Stock Options

ISOs are options granted by a corporation within a plan qualified under Internal Revenue Code (the “Code”) section 422.  Options that meet section 422 requirements may be issued and exercised without any immediate tax liability to the recipient; tax liability arises when the recipient sells the stock.  The Code requires the recipient to hold the stock for at least two years after the grant of the option, and at least another one year after exercising it. Upon selling the stock the recipient reports the amount received, minus the exercise price, as a long-term capital gain.  Recipients generally find options granted via an ISO plan more advantageous, however, they are generally more burdensome for the corporation to establish and maintain compared to other plans which offer stock in exchange for services.  The statutory requirements for the qualification of an ISO plan include the following:  (a)  it must be granted under a detailed “plan” which states the number of shares that may be issued, the employees or class of employees eligible to receive grants and be approved by the shareholders of the corporation within twelve months before or after the date the “plan” is adopted;  (b)  it must be granted within ten years after such adoption or approval of such “plan”, whichever is earlier;  (c)  it must have an exercise price of the option that is not less than fair market value of the stock as of the grant date;  (d)  it must be exercisable by the employee only within ten years from its grant date, or five years if the recipient owns 10% or more of the company ( a further requirement in such circumstances is that the exercise price of the option must be at least  110% of fair market value);  (e)  it must be nontransferable;  (f)  it must require the recipient to be an employee of the corporation from the date of the grant of the option until three months before the exercise of the option;  (g)  it must not exceed an aggregate amount of $100,000 per employee per calendar year;  and,  (h) it must meet other statutory and reporting requirements.

Nonstuatory Stock Options

“Nonstatutory Stock Options” (also called “nonqualified stock options”) are options that do not meet the requirements of an ISO.  These options do not need to be issued pursuant to a “plan”; furthermore, if a “plan” is used it is not required to adhere to the provisions of an ISO plan.  If an NSO has a “readily ascertainable fair market value” at the time it is granted, then the option is taxed to the recipient at the time of such grant.  If the option does not have a “readily ascertainable fair market value” when it is granted, then the recipient is taxed when the option is exercised and tax is paid on the difference between the stated option price and the value of the stock at the time the option is exercised.  In either case, the tax rate that is applied is the applicable ordinary income tax rate (currently ranging from 10% to 35%) rather than the lower long-term capital gain tax rates (applicable to stocks that are held for longer than one year).   According to Treasury Regulation section 1.83-7 (b)(1), options that are actively traded on an established market are considered to have a fair market value that is “readily ascertainable.” Options that are not actively traded on an established market most likely will not have a “readily ascertainable” fair market value because of the difficulty of substantiating such a position which can be supported if the taxpayer complies with the following requirements:  (1)  the option must be freely transferable;  (2)  the option must be exercisable immediately in full;  (3)  neither the option nor the stock can be subject to any restriction which has a significant effect on the fair market value of the option;  and (4)  the following factors are fulfilled:  (i)  the value of the stock subject to the option is ascertainable;  (ii) the probability of any ascertainable value of such stock increasing or decreasing is obtained;  and (iii)  the length of time during which the option is exercisable can be determined.    Treasury Regulations sections 1.83-7(b)(2) and (b)(3).

Restricted Stock

Generally, options such as an ISO or NSO represent a right and not an obligation to purchase a corporation’s stock for a pre-determined price within a stated period of time.  An alternative to stock options is the issuance of “restricted stock” which is stock that is actually issued to a service provider but it is issued subject to certain restrictions.  A corporation has wide latitude in determining the restrictions it will place on such stock transfers.  Some of the more common restrictions include performance based criteria or vesting criteria.    These criteria may be based upon such things as exceeding stated corporate economic goals or the requirement that the employee remain an employee of the company for a certain period of time.  In the context of “restricted stock”, vesting refers to a time when such stock is no longer subject to being reclaimed by the company from the recipient.   For tax purposes, if stock is received outright in exchange for the performance of services (i.e., without being subject to restrictions), then the recipient is immediately taxed on the difference between the value of the stock and the amount (if any) the recipient paid for such stock.  In such a situation the recipient would be required to pay a tax at ordinary income tax rates (currently ranging from 10% to 35%).  However, if the stock is subject to “a substantial risk of forfeiture” then, for tax purposes, the recipient has received “restricted stock.”  In such instances, tax consequences will apply in the first taxable year when the interest in the stock is either not subject to “a substantial risk of forfeiture” or is transferable free from any substantial risk of forfeiture affecting the stock.  In such first taxable year the recipient is taxed to the extent the fair market value of the stock exceeds the amount (if any) paid for such stock.  This taxable amount is subject to the applicable ordinary tax rate (currently ranging from 10% to 35%).  In either situation the employee can expect to pay tax at ordinary income tax rates, whether immediately in the former situation or at a subsequent date in the latter situation.  The recipient should be aware of a possible tax trap when receiving restricted stock.  Even if the recipient recognizes the tax trap, exactly how to handle it remains an issue because whether the stock’s value will increase or decrease over time and whether or not the stock will be forfeited before it vests with the employee cannot be easily predicted.

By way of example, consider a case where a company gives compensation to an employee which includes 100,000 shares of stock having fair market value of $1 a share in the year 2008 with the proviso that the shares are subject to complete forfeiture if the employee fails for any reason to remain in the employ of the company for five years.  This would be considered a “restricted stock” issuance.  Although the shares are valued at $100,000 on the date they are granted in 2008, the employee does not owe tax on the $100,000 in 2008 because the stock is subject to a “substantial risk of forfeiture” (i.e., he or she must remain employed with the company for five years before the stock vests).  If the employee fulfills the five year requirement and the value of the shares rises to $1,000,000, the employee will be very happy, that is until April 15th when he or she is informed that $1,000,000 will be included in his or her ordinary income in that year because that the stock is no longer subject to the “substantial risk of forfeiture”.  The tax would be due whether or not the taxpayer sells the shares. The issue with “restricted stock” is a “timing” one in that if the stock had been included in the employee’s income in 2008, he or she would have been responsible to immediately pay income tax (at ordinary tax rates) on $100,000.  No additional tax liability would have been incurred until he or she disposed of the stock at some future date.  Further, if that date were to be more than one year from issuance it would be taxed as a long-term capital gain which would represent a significantly lesser tax obligation than if taxed at an ordinary income rate (at existing rates).

However, Code section 83 is designed to address this situation.  A taxpayer who receives “restricted stock” (i.e., stock subject to “a substantial risk of forfeiture”) is allowed to make a “section 83(b) election” by which the taxpayer, upon receipt of the stock, may report the excess of the current value of the stock received ($100,000 in the above example) over the amount paid for the stock (if anything) which is taxed at ordinary tax rates in the year received (2008 in the above example).  For a section 83(b) election to be valid it must meet certain requirements, not least of which is that the election must be made within thirty days of the transfer of the stock.  Under Treasury Regulations section 1.83-2 (f), the Internal Revenue Service will only consent to a revocation of election in cases where the employee is under a mistake of fact as to the underlying transaction (and such request must be made within sixty days of the date on which the mistake of fact first became known).  Generally, a mistake about the tax consequences of making an election, or the inability to pay the tax, or the mistaken belief that the stock would appreciate and not decline or similar types of mistakes will not provide grounds for revocation of the election.  As mentioned above, as to whether the stock’s value will increase or decrease by the time the stock is no longer subject to a “substantial risk of forfeiture” and whether or not the stock will be forfeited before it vests with the employee are factors which make the section 83(b) election more of a gamble.  If the stock in the above example should decline to $.10 per share by year five, then the employee paid income tax (and federal and state employment tax withholding) on $100,000 when issued rather than the lower amount of $10,000 in year five when the stock vests.  It is also not guaranteed that the employee will fulfill the requirements (such as remaining an employee for five years) in which case the stock never vests and the employee paid tax on stock he or she never received.

As a practical matter, tax consequences of ISOs, NSOs and restricted stock are often overlooked by the recipient until it is too late for the application of the most efficient tax planning.  Such practical factors include the short time period normally associated with negotiation and consummation of employment agreements and the possibility of severe negative financial consequences by the failure of the recipient to recognize the need to consult a tax attorney at the earliest stage of the process.

Legal Disclaimer: The information contained herein is general in nature. It is for informational purposes only and provides an overview of a few legal principles. The information provided is not guaranteed to be up to date or correct. The information contained in this blawg is not, nor is it intended to be, legal advice. It should not be relied upon in making specific legal decisions, but you should consult an attorney regarding your specific situation. Receiving this transmission and/or reading the information in this transmission does not establish an attorney-client relationship. A written, signed retainer agreement is required for representation.


New World Of Distribution For Indie Filmmakers

September 18, 2008

Peter Broderick has published an article in IndieWIRE summarizing the changing landscape of film distribution and outlining “ten guiding principles of New World distribution.”