You've heard of optional income — employees receive stock options on top of cash.  The Department of Labor (DOL) may have put a damper on these pay arrangements for good, by concluding that profits non-exempts realize from exercising their options must be included in their regular rates for purposes of calculating their overtime rates.

 

A one-shot deal.  Stock options under this employer’s plan would be offered only once.  Full-time employees would receive options for 100 shares of stock with the price of the options fixed for five years.  Options would be exercisable at the earlier of two years after the grant date or immediately, if the stock was traded at or above a set price for a certain number of days.  Other highlights of the plan included:
    • when employees gave notice of exercise, the company would lend them the funds
    to buy stock (i.e., the exercise would be “cashless”).  The profit would be the difference between
    the grant price and the stock price when the options were exercised;
    • the company would automatically exercise unexercised options on the day before the
    five-year period expires; and
    • employees who leave the company would have their unexercised options canceled.

The question for the DOL was whether the profits that non-exempt employees would earn when they exercised their options and bought stock could be excluded from their regular rates for overtime calculation purposes.

The shot heard round the world.  The profit was unlike cash gifts, holiday and discretionary bonuses, and payments under profit-sharing plans, all of which may be excluded from non-exempts’ regular rates, said the DOL.   So it must be included in the regular rates when figuring their overtime rates.  DOL: The profit must be allocated over the time period during which it was earned, starting with the day employees could exercise their options and ending with the week the options were exercised.  Small break: Due to a two-year statute of limitations, allocations may be cut off after two years.

Example.  Ann exercises her options after three months (13 weeks) and earns a $1,750 profit.  The $1,750 is attributed to the prior 13 weeks, ending with the week the options are exercised.  During these 13 weeks, she worked 520 hours of straight time and 200 of overtime.  Taking the profit into consideration, Ann’s regular rate increases by $2.43 ($1,750 ÷ 720).  Ann must be paid an additional $244 (200 x $1.22) in overtime.

Example.  Ben exercises his options after three years (156 weeks) and earns $7,800.  Due to the two-year time limit, his profit is attributed to the prior 104 weeks, ending with the week the options are exercised.

CEASE FIRE

The DOL stressed that its opinion was directed only to the requesting employer.  It didn’t want to suggest that all stock option plans would be treated the same way.  In other instances, it noted, a stock option plan would be treated similar to a profit-sharing plan, so profits could be excluded from employees’ regular rates.  However, in trying to quell the uproar in the employer community over this ruling, the DOL recently went further and said it would reconsider this ruling.

77 words about taxes.  Almost certainly, these options were non-statutory stock options, or NSOs, without a fair market value (FMV) when granted. You must withhold income and FICA taxes when these options are exercised.  What’s taxable: the spread between the exercise price and the stock’s FMV at the time of exercise.  For income tax withholding, you may withhold at the 28% supplemental rate.  After withholding, the gain or loss on the value of the stock is a capital gain or loss.