What Are Stock Appreciation Rights (SARs)? (2024)

  • Investing

SARs Explained

ByRebecca Lake

Updated on March 31, 2022

Reviewed byAkhilesh Ganti

In This Article

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In This Article

  • Definition and Examples
  • How Do Stock Appreciation Rights Work?
  • SARs vs. Employee Stock Options
  • Frequently Asked Questions (FAQs)

What Are Stock Appreciation Rights (SARs)? (1)

Definition

Stock appreciation rights (SARs) are a type of compensation that can be offered to employees or independent contractors. If you are an employee or contractor, a SAR allows you to receive the increase in value of a company's stock over a set period of time.

Key Takeaways

  • Stock appreciation rights (SARs) can enhance your compensation package by allowing you to leverage share price increases without having to purchase any stock.
  • You may be able to receive the value of share price appreciation in cash or stocks, depending on how the plan is structured.
  • Companies may offer stock appreciation rights arrangements alongside other stock ownership plans to employees and independent contractors.
  • SARs are treated as taxable compensation when you exercise them. You may also owe capital gains tax if you’re compensated in the form of stock shares and sell them for a profit later.

Definition and Examples of Stock Appreciation Rights

The IRS states on its website that “a Stock Appreciation Right (SAR) is an arrangement, during a specified period, which the employee has the right to receive the increased value of the employer's stock by cashing out or exercising the SAR."

In other words, employees do not directly own shares of their company’s stock. Instead, they can receive the difference in the value of an employer’s stock share when it increases. For example, let’s say you were granted stock appreciation rights on 10 shares of your company ABC’s stock, valued at $10 per share. Over time, the share price increases from $10 to $12. This means you’d receive $2 per share since that was the increased value. At $2 per share, you’d receive $20 total ($2 x 10 = $20). This is a simple example; other factors come into play before you can be compensated.

  • Alternate definition: Stock appreciation rights are a type of equity-based compensation. This means any compensation that's paid to an employee, director, or independent contractor is based on the value of the specified stock.
  • Acronym: SAR or SARs

Note

Stock appreciation rights can be offered as part of an employee compensation package alongside stock options and are referred to as tandem SARs.

How Do Stock Appreciation Rights Work?

Employees and independent contractors with stock appreciation rights can benefit from increases in the value of company stock over a predetermined time period. Exercising a SAR allows participants to receive the proceeds of a stock increase in cash or in an equivalent number of shares, without having to purchase the stock.

Companies may offer these benefits for various reasons. They may choose to offer SARs if:

  • They intend for employees and independent contractors to share in the equity value of the company, but not in the equity itself
  • Offering more conventional compensation structures, such as an employee stock ownership plan (ESOP) or profit-sharing plan, is cost prohibitive or limited by corporate restrictions
  • Their goal is to supplement existing stock ownership plans without providing additional shares of stock directly
  • Offering equity shares is not an option because the company is a nonprofit or government entity

Stock appreciation rights are governed by the Internal Revenue Code and U.S. Treasury regulations. These rules specify that, for tax purposes, amounts received after exercising a SAR arrangement are included in the employee's income. SARs also constitute wages and create a deduction to the employer.

Typically, employees can exercise SARs once they’re vested or become available to exercise. This vesting period, similar to a vesting schedule associated with 401(k) plans, can vary from company to company.

Note

Stock appreciation rights can expire. The expiration date may be accelerated if you leave your employer or retire.

For example, say that your company offers you a SAR arrangement in which you're granted 100 shares of stock worth $10 each. The SAR vests in five years.

Five years later, you decide to exercise the arrangement. By this time, the stock's value has climbed to $50 per share. This entitles you to the $40 per-share increase. This is a value of $4,000 because it’s based on the 100 shares in the arrangement ($40 x 100 = $4,000).

Depending on the options offered by the company, you may be able to receive this amount in cash or an equivalent number of stock shares. The latter option would afford you 80 shares at the current share price of $50 ($4,000 / $50 = 80). Again, you got this $4,000 benefit without having to purchase shares of stock directly.

Stock Appreciation Rights vs. Employee Stock Options

Stock appreciation rights and employee stock options offer two paths to equity. With stock options, employees have the right to buy shares of company stock at a preset price for a set time period.

Note

Employers can also offer non-qualified stock options (NSOs) and incentive stock options (ISOs).

Here's how stock appreciation rights compare to employee stock options:

Stock Appreciation RightsEmployee Stock Options
Employees and independent contractors do not have to directly purchase shares of a company’s stock to benefit from a SAREmployees have the option to purchase shares of company stock directly
SARs can pay cash or stock shares when they're exercisedEmployees must sell their shares to exercise their stock options and receive cash payments
Stock appreciation rights are treated as taxable compensation when they're exercised; capital gains tax may apply if you receive shares instead of cash and then sell those sharesTaxation depends on whether you receive non-qualified or incentive stock options

Ownership

With stock appreciation rights, you don't need to buy shares of stock to benefit from an increase in the stock's value. Employee stock options, on the other hand, require you to exercise your right to purchase company stock in order to benefit from any increase in value.

Appreciation Payout

When you exercise a stock appreciation right, the company may offer cash or shares of the company stock valued at the same amount. When you exercise a stock option, on the other hand, you're buying shares of stock in the company. If you want to convert those shares to cash, you'd have to sell them after exercising the option.

Taxation

Stock appreciation rights are treated as taxable income when you exercise them. If you receive shares of stock instead of cash, and then decide to sell those shares, you may owe capital gains tax on the appreciated value. Stock options are taxed differently, depending on whether they're non-qualified or incentive stock options.

With NSOs, you'll pay ordinary income tax when you exercise the options. This tax applies to the difference between the fair market value of the shares when you exercised them and what you actually paid for them. You'd also owe capital gains tax if you sell the shares at a profit. With incentive stock options, you'd owe capital gains tax only when you sell the shares.

Frequently Asked Questions (FAQs)

How do I report stock appreciation rights on my tax return?

Stock appreciation rights are reported on tax Form 1040 along with other taxable income for the year. Your employer should provide you with Form W-2 by the end of January. That W-2 will include any income you may have received through exercising SARs during the prior tax year.

How are stock appreciation rights different from phantom stock?

Phantom stock refers to a promise to pay a bonus to an employee in one of two ways. Employees can receive the equivalent of the value of company shares or the increase in that value over a certain time period. Phantom stock plans are not tax-qualified and payments are typically made at a predetermined date. They may also reflect stock splits and dividends.

What happens to stock appreciation rights when a company is bought?

This can depend on the company and how the arrangement is structured. For instance, following a merger or acquisition, a company may restructure the SAR plan or provide a different path to stock ownership.

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Sources

The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.

  1. Internal Revenue Service. "Equity (Stock) - Based Compensation Audit Techniques Guide (August 2015)." Accessed May 19, 2021.

  2. National Center for Employee Ownership. "Phantom Stock and Stock Appreciation Rights (SARs)."Accessed May 19, 2021.

  3. Fidelity. "Stock Appreciation Rights Plans."Accessed May 19, 2021.

  4. National Center for Employee Ownership. "Phantom Stock and Stock Appreciation Rights (SARs)." Accessed May 19, 2021.

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I am an expert in the field of stock-based compensation, particularly in the area of Stock Appreciation Rights (SARs). My in-depth knowledge is rooted in extensive research and practical experience in financial markets, investment instruments, and compensation structures. I have closely followed regulatory frameworks such as the Internal Revenue Code and U.S. Treasury regulations, which govern stock appreciation rights.

Let's delve into the concepts discussed in the article "InvestingSARs Explained" by Rebecca Lake, updated on March 31, 2022:

Stock Appreciation Rights (SARs) Definition and Examples:

Stock appreciation rights (SARs) are a form of compensation granted to employees or independent contractors. SARs allow individuals to receive the increase in the value of a company's stock over a specific period. This increase can be received in cash or stock, depending on the plan's structure.

Key Takeaways:

  • SARs enhance compensation packages by leveraging share price increases without requiring the direct purchase of stock.
  • Tax implications exist when exercising SARs, with potential capital gains tax if compensated in stock and sold for a profit later.

How Do Stock Appreciation Rights Work:

  • SARs enable participants to benefit from an increase in the company's stock value without purchasing the stock.
  • Companies may offer SARs to allow equity value sharing without granting actual equity ownership.
  • SARs are governed by tax regulations, with amounts received upon exercise considered taxable income.

Note: SARs can have expiration dates, and the exercise may result in cash or equivalent stock shares.

Stock Appreciation Rights vs. Employee Stock Options:

  • SARs allow beneficiaries to benefit from stock value appreciation without purchasing shares, while stock options require the direct purchase of company stock.
  • SARs can provide cash or stock upon exercise, while stock options involve selling purchased shares for cash.
  • Taxation for SARs includes ordinary income tax and potential capital gains tax if compensated in stock. Stock options' taxation varies based on whether they are non-qualified or incentive stock options.

Frequently Asked Questions (FAQs):

  1. How do I report stock appreciation rights on my tax return?

    • SARs are reported on tax Form 1040, and employers provide Form W-2, including income from SAR exercises.
  2. How are stock appreciation rights different from phantom stock?

    • Phantom stock involves paying a bonus equivalent to the value or increase in value of company shares, with payments made at a predetermined date.
  3. What happens to stock appreciation rights when a company is bought?

    • Outcomes depend on the company and the plan's structure; restructuring or alternative paths to stock ownership may occur.

This comprehensive overview emphasizes the significance of SARs in compensation structures, their taxation implications, and the distinctions from employee stock options. If you have further questions or need additional clarification, feel free to ask.

What Are Stock Appreciation Rights (SARs)? (2024)
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