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What happens to an employee's stock options when he converts to consultant status ?

 partially vested sharesAn employee has ISO options that are partially vested.  The employee voluntarily terminated regular employment but decided to stay on as an "on-call" consultant.  The employee prefers stock compensation vs. cash compensation.  Can he keep his ISO options and extend the vesting until the consulting engagement ends (this would be his compensation)?


Topic Expert
Barrett Peterson
Title: Senior Manager, Actg Stnds & Analysis
Company: TTX
(Senior Manager, Actg Stnds & Analysis, TTX) |

ISO plans typically spell out employment status requirements and provide for what happens at termination of employment. Your former employee has terminated employment and become a consutant. Your plan document should address this. This person's status as a consultant is subject to question under IRS rules.

Elizabeth Dodge
Title: VP
Company: Stock & Option Solutions
(VP, Stock & Option Solutions) |

ISOs can only offer their preferential tax treatment (no tax at exercise, only later, at disposition) to employees. So 3 months after the individual stops being an employee, the preferential tax treatment also ends. However, if the terms of the plan allow it (check the language to see if the language is "continuation of service" or "employment"), the option may continue and simply be treated as a non-qualified stock option (spread at exercise taxed as ordinary income). Even if the grant agreement/plan does specify that option should be cancelled at the time that employment ends, you can modify the option to change that condition.

Remember that accounting for non-employee options under FAS 123(R) / ASC 718 is very different than accounting for employee options - the fair value is not "set" until the vest date and must be remeasured each quarter until the vest occurs AND if you modify the grant, you may need to apply modification accounting to account for the change.

Topic Expert
Bob Stenz
Title: Controller
Company: Silicon Valley start-up
(Controller, Silicon Valley start-up) |

If the ISO is modified (say extended), if becomes a NSO. The re-characterization to NSO will result in W-2 income (upon exercise) and employment taxes (both employer and employee). At least that's my experience, your situation may vary.

Ted Monohon
Title: VP -Finance / Controller
Company: Fantex
(VP -Finance / Controller, Fantex) |

Although Elizabeth's answer is correct, please be aware that you must modify the twrms of the option prior to the change in status and it should be done at a board meeting or by resoultion. Most plans do not allow retroactive changes to the terms of the grant. If you are contemplating a change in status contact your sticl paln administrator prior to your change.

Tom Bondi
Title: Principal, Emerging Businesses
Company: Berger Lewis
(Principal, Emerging Businesses, Berger Lewis) |

I would like to add: the ISO's will terminate to be characterized as ISO's (just as Elizabeth indicated) after the 90 days. Therefore, if the recipient would wish some shares to receive the ISO treatment then those vested shares would need to be exercised before the 90-day period expires. The only way to keep an ISO characterization is the individual must continue to be treated as an Employee. Additional considerations would be: attempting to modify the Grant, while beneficial for the Employee is not always beneficial for the Company. Additionally, this recharacterization from Employee to I/C (Independent Contractor) may not be a good move for the company. If the individual continues to carryon the same duties and does not meet the test of I/C then this will put the Company at risk for Employment Taxes. Generally when companies "extend" the vesting period beyond the 90 days upon a technical departure we would have the Company run all of the Ordinary Income through Payroll for the post-90-day exercises and subject to all withholding taxes to eliminate any risk to the Company. You'll need to review the requirements of a technical "Modification" since in some cases requires a new Grant price to be set.

If the individual is actually changing his/her role in the company and meets the tests to be treated as an I/C then you may want to let this Grant expire at the 90 days and determine if a new relationship should be established with a very different package, milestone driven.

Topic Expert
Keith Perry
Title: Director of Global Accounting
Company: Agrinos, Inc.
(Director of Global Accounting, Agrinos, Inc.) |

My thoughts exactly, Tom. Make a clean break for the old plan and start new, with something that is appropriate functionally and legally.

(controller) |

What happens to a consultant's stock option when he converts to an employee?
A consultant who is consulting CFO has NQ options that are partially vested. The consultanting CFO was converted into regular employment as CFO. How to expense his NQ options when he became employee?


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