Confusing Stock Option Language

[Steve7]

Jurisdiction

North Carolina

I received an employment agreement from a company offering me stock options that vest over time, annual profit sharing, and periodic distribution sharing whenever the founders decide to distribute.

This language below should have addressed the profit and distribution sharing, but I'm completely confused by it. Any help is appreciated.

Subject to the approval of the Board, for each calendar year while you remain employed with the Company, during any period when you are not a stockholder of the Company but hold the Option, a discretionary bonus equal to the amount you would have received in any distributions made by the Company to its stockholders as if your Option (together with any additional equity of the Company you may subsequently acquire) were fully-vested and exercised; provided, that distributions made to the stockholders of the Company for payment of such stockholders' income tax obligations with respect to taxable income allocated to them by the Company shall not be included in determining such amounts.

 

[Tax Counsel]

I received an employment agreement from a company offering me stock options that vest over time, annual profit sharing, and periodic distribution sharing whenever the founders decide to distribute.

This language below should have addressed the profit and distribution sharing, but I'm completely confused by it. Any help is appreciated.

Subject to the approval of the Board, for each calendar year while you remain employed with the Company, during any period when you are not a stockholder of the Company but hold the Option, a discretionary bonus equal to the amount you would have received in any distributions made by the Company to its stockholders as if your Option (together with any additional equity of the Company you may subsequently acquire) were fully-vested and exercised; provided, that distributions made to the stockholders of the Company for payment of such stockholders' income tax obligations with respect to taxable income allocated to them by the Company shall not be included in determining such amounts.

Basically this says that while you are not a shareholder of the company but you do hold options you'll get a bonus equal to the stock distributions you'd have gotten had the options been vested and exercised — i.e. a bonus in the same amount you'd have gotten as a stock distribution had the options been converted to stock. So, for example, let's suppose your option when you exercise it would result in you owning 1 share of stock. The company makes a distribution of $2 per share for this year. The company would treat your option as though you held 1 share of stock and you'd get the $2 distribution that the shareholders get for each of their shares.

The one exception here is that your option bonus would not include any extra distribution that shareholders get to help them pay the income tax on their share of the company income. This tells me that the company is a S-corporation. With a S-corporation the corporation does not pay income tax and instead the shareholders are taxed on their personal returns for their share of the corporate net income. This corporation evidently helps out shareholders in paying that tax by making extra distributions to them. As someone holding only an option and not stock you'd not need that help because you don't get taxed on a share of the corporation's net income simply for holding an option.