Stock options and warrants are similar in many ways. Both provide the right to buy a company’s stock for a certain period and at a fixed price, as specified in a contractual agreement. But these instruments are used in different circumstances. Stock options are usually part of an overall compensation package offered to employees or consultants, whereas warrants are an instrument to entice and reward investors.

In addition, investment warrants and stock options are structured differently. Unlike warrants, compensatory stock options typically are granted under an equity incentive plan and they are governed by a vesting scheme.

Finally, there is a profound difference in taxation between warrants and stock options.

 

Warrants as compensation

Warrants typically are issued to investors, but it’s not illegal to receive one as compensation for your services. Realize, though, that you will likely be taxed in the same way as if you had received a stock option. If you receive a warrant as compensation, you should consider the following:

  • The warrant should have an exercise price equal to the fair market value of the underlying stock on the date of grant in order to avoid additional taxes under Section 409A.
  • When you exercise the warrant, the excess of the fair market value of the shares received over the exercise price would be taxed the same way as regular income.
  • If you’re an employee, you will need to withhold income and employment tax upon exercise.
  • If you’re an independent contractor and not an employee, you would not need to withhold income and employment tax, but you would need to report it to the IRS, using Form 1099.

 

Tax implications of investment warrants

An investor won’t be taxed as described above as long as the warrant is received as an incentive to make an investment and not as compensation for services provided. This doesn’t mean, though, that you never owe taxes on warrants. If a warrant is issued, for example, as part of a note, there’s usually an original issue discount that needs to be accounted for as income over the term of the note.

If you’ve received a warrant related to an investment, your best bet is to consult with a tax advisor to make sure you understand all the tax implications.

 

Guest blogger Joe Wallin is a leading startup lawyer in the Pacific Northwest and the founder of the Law of Startups. He represents companies from inception to exit, as well as investors, executives, and founders. His practice focuses on startups and emerging companies, angel and venture financing, and M&A transactions. Follow him on Twitter @joewallin

Looking for funding?

Lighter Capital provides tech startups up to $2M of non-dilutive growth capital in a fraction of the time it takes to raise from traditional sources. No loss of control. No personal guarantees. No hassle.

Apply for funding