What You Should Know About Stock Appreciation Rights

A stock appreciation right, or SAR, is a compensation tool employers can use to attract and retain key employees. Like employer stock options, stock appreciation rights allow you to benefit from appreciating stock prices should the company’s stock price rise over a specified time period.

They’re also similar in that SARs are issued with a grant date, an exercise price, a vesting date, and an expiration date — but unlike stock options, you are not required to pay the exercise price of the SAR and may only receive the value in excess of the exercise price on the date of exercise. SARs are generally settled in cash, but can also be settled in stock depending on your plan document.

The fact that your SARs may leave you with cash instead of company stock may impact your financial plan in a different way than other kinds of equity compensation. Here are some things you should know about SARs.

How does a stock appreciation right work?

SARs are similar to non-qualified stock options. They are granted as part of a compensation package and they’re issued with key dates and figures of which you should be aware:

Exercise price: The exercise price is the fair market value (often the price on the market) of the stock on the grant date and it’s used to determine the amount you receive upon exercise of your SARs. If the current stock price is above the exercise price, your SAR is “in the money.” If the current stock price is below the exercise price, the right is “under-water.”

Vesting date: This is the first day you can exercise some or all of your SARs. Prior to this date, even the in-the-money value cannot be captured. Once your SARs vest, you can exercise the right and capture the value.

Expiration date: This is the last day you can exercise your SARs. For SARs with a market price below the exercise price, shares will likely expire as worthless. For SARs with a market price that exceeds the exercise price, exercising your stock appreciation rights may be a favorable option.

Grant date: The grant date is the date the stock appreciation right is granted to you. This date also determines the exercise price.

Your SARs at grant may look like something like this:

• Grant Date: January 1, 2024
• Market Price at Grant (Exercise Price): $10
• Number of SARs: 1,000
• Vesting Date: January 1, 2025
• Expiration Date: December 31, 2034

 

To illustrate the potential value of SARs, let’s assume that on January 1, 2025 (when your SARs vest), the share price of your company stock is $50. The value of your SARs is equal to $40,000 (subject to taxes). The math is:

(Market price at exercise – exercise price) * number of rights exercised

($50 – $10) * 1,000 = $40,000

If your plan allows for SARs to be settled in shares of stock, you can calculate how many shares you will receive as follows:

Value to be received upon exercise/ market price at exercise = shares received

$40,000 / $50 = 800

In a stock settlement scenario, you will receive 800 shares of stock instead of $40,000 cash. The value of the award, minus any consideration paid for it (usually none) is taxed as federal ordinary income.

Since your SARs are vested, you generally have two choices to consider:

1. You can exercise the SAR (some or all), pay the tax, and receive the proceeds of the sale
2. You can leave the SAR unexercised

 

Unexercised SARs will be subject to future stock price fluctuations. Should the stock price continue to go up, your SARs will become more valuable. Should the future stock price decrease, it’s possible that you can lose some or all of the value that the SAR had on the vest date.

The decision on whether to exercise or wait is yours. However, if your SARs are in the money, you will want to exercise your right prior to the expiration date. Otherwise, you risk losing the right to do so, and forfeiting the value.

How are SARs taxed?

The grant of a SAR is a non-taxable event. Like non-qualified stock options, you don’t have to report anything for federal tax purposes until you exercise.

When you do exercise your SARs, the difference between the market price at exercise and the exercise price, multiplied by the number of SARs exercised, gets taxed as ordinary compensation income and is subject to federal and state and local income tax in addition to payroll taxes. Depending on your plan document, the tax due will likely be paid from the cash generated during the exercise via a tax withholding.

Following our general example above, the amount of taxable income (which will appear on your W-2) is $40,000. If we assume a federal tax withholding of 22% and a payroll tax of 7.65%, your estimated tax withholding would be $11,860. However, your total tax liability at year end can vary from the amount of tax withheld at the time of exercise. Note that there may also be state and local income tax consequences upon exercise.

Due to the federal taxes withheld from the SARs, your net proceeds from exercising your rights would be $28,140.

Planning for SARs

SARs are similar in some ways to non-qualified stock options. For this reason, many of the planning considerations remain the same.

If you find yourself with SARs, you should begin by asking a few of the following questions:

• When is the best time to exercise my SARs?
• How will the exercise of SARs impact my tax return?
• How does this fit into my overall financial and retirement plan?

 

Many of the answers to these questions may be the same as they are for employee stock options.

Determining when to exercise your SARs and what to do with the proceeds or stock once you exercise is something that should be developed in accordance with your financial plan.