Employers may compensate their workers with stock rather than regular pay both to motivate employees -- giving them a direct stake in the company's success -- and to conserve cash. For tax purposes, stock given to workers in lieu of pay is treated like regular income. It may not be cash, but it has value, and you're taxed on that value.
In general, the tax treatment for stock received as compensation for your services -- that is, stock in lieu of pay -- is the same as for regular pay. You must pay income taxes on the fair market value of the stock you received. Say an employer gave you 100 shares of stock in lieu of pay, and on the day you received the shares, the stock was trading at a price of $40. You've received the equivalent of $4,000 in income, so you'll be responsible for paying taxes on $4,000 in income. How much that tax will be depends on your tax bracket.
Conditional Stock Grants
Some employers compensate workers with stock, but they attach conditions to the stock. For example, you might "earn" 100 shares of stock in your first year, but you don't get full ownership of the shares -- and therefore the right to sell them -- until you've been with the company for two years. You'll still have to pay income tax on the value of the stock -- but not until you're "vested," meaning the stock is yours to do with as you wish.
You're required to pay Social Security and Medicare payroll taxes on the wages you receive. Under tax law, any compensation provided to an employee in return for services is considered wages, whether that compensation is cash or something else. So if you received $4,000 worth of stock in lieu of pay, you would not only owe income taxes, but also the payroll taxes. As of 2013, employees' combined Social Security and Medicare tax rate was 7.65 percent, which comes out to $306 on $4,000 worth of compensation.
If your employer gives you stock as compensation, check with the payroll department to make sure that sufficient taxes are being withheld from your regular cash pay or to discuss arrangements for paying the necessary taxes. Otherwise, you could be in for an unpleasant surprise come tax time. If you're a contractor or a self-employed person and receive stock in lieu of pay from a customer or client, the market value of the stock is treated as business income. You'll calculate your income tax and self-employment tax the same as if you'd received the value in cash.
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.