Answers|Dictionary

Can I give stock options to a contractor?

EquityStock optionsContractorsTax

Yes, but only nonstatutory options. The tax code reserves incentive stock options for employees, so a contractor gets an NSO, granted under the same equity incentive plan, approved by the same board consent, and priced at or above the same 409A fair market value. The difference is at exercise: the contractor recognizes ordinary income on the spread, reports it themselves, and the company withholds nothing.

The same plan, the same approvals

The paperwork does not change because the recipient is a contractor. The board approves the grant, fixing the number of shares, the exercise price and the vesting, and the contractor signs a grant notice and an option agreement. Vesting is often tied to the term of the engagement or to deliverables rather than to a four-year schedule, and what happens if the engagement ends early should be decided before the consent is signed, not after.

The securities condition

A private company grants compensatory equity under Rule 701. For consultants and advisors the rule adds a condition employees do not face: the recipient must be a natural person, must provide bona fide services to the company, and those services must not be in connection with the offer or sale of securities in a capital-raising transaction. A contractor hired to find investors does not qualify. Neither does a grant to a consulting firm rather than to the individual doing the work, so the usual practice is to grant to the person.

Tax at exercise

An NSO priced at fair market value has no tax at grant. At exercise, the difference between fair market value that day and the exercise price is ordinary income. For an employee that goes on a W-2 with withholding. For a contractor it is nonemployee compensation, reported on a Form 1099-NEC once the year's payments reach the reporting threshold, and the contractor pays the tax, including self-employment tax, with their return. Early exercise with an 83(b) election is open to a contractor on the same terms as an employee if the plan allows it.

Arabella's simple NSO package for a Delaware corporation is built for this grant, filled by one questionnaire.

Written by the lawyers who built Arabella. This is legal information, not legal advice for your situation, and reading it does not make us your lawyers. For a real dispute or a high-stakes decision, talk to a licensed attorney. More questions.