# Understanding Stock Appreciation Rights (SARs): Benefits and Tax Implications

![Stock Appreciation Rights (SARs): Employee compensation linked to the company's share price during a predetermined period.](https://www.investopedia.com/thmb/xzpxHk-rAYVusJdW3_EFhHrOPpI=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Sar_final-fd13de9031f147c28c1dca8dde901640.png)

*— Investopedia / Michela Buttignol*

## What Are Stock Appreciation Rights (SARs)?

Stock appreciation rights (SARs) offer employees the opportunity to benefit from the rising stock prices of their company without the need to purchase shares. Unlike stock options, SARs typically don't require an exercise price, and they often provide cash or stock equivalent to the price increase over a specified period. Employers and employees alike find SARs advantageous, as they can motivate staff while minimizing share dilution.

### Key Takeaways

*   Stock appreciation rights (SARs) enable employees to gain financially if the company's stock price increases without needing to buy the stock.
*   Unlike traditional stock options, SARs are often settled in cash and do not require employees to make an upfront purchase.
*   Employers issue tandem SARs alongside stock options to help employees fund option purchases or cover taxes.
*   SARs are subject to taxation upon exercise, with income recognized as ordinary income, similar to non-qualified stock options.
*   Clawback provisions in SAR agreements allow companies to reclaim SARs if employees leave under specific conditions.

## How Stock Appreciation Rights (SARs) Function

[Stock appreciation rights](https://www.investopedia.com/articles/stocks/12/introduction-phantom-stock.asp) offer the right to the cash equivalent of a stock's price gains over a predetermined time interval. This bonus is almost always paid in cash by employers. However, the company may pay the employee a bonus in the form of shares. In most cases, employees can exercise SARs after they vest. When SARs vest, it means they become available to be exercised. Employers generally issue SARs along with stock options. These stock appreciation rights are called tandem SARs. They assist in funding the purchase of options and help pay off taxes due at the time the SARs are exercised.

Like other [stock compensations](https://www.investopedia.com/terms/s/stockcompensation.asp), SARs can be transferred and often have [clawback conditions](https://www.investopedia.com/terms/s/stockcompensation.asp). Clawback provisions allow a company to reclaim some or all income from the plan under certain conditions. For example, they might allow the firm to withdraw SARs if an employee goes to work for a competitor before a specified date. SARs are also frequently awarded according to a vesting schedule that ties them to performance goals set by the company.

SARs are taxed like [non-qualified stock options (NSOs)](https://www.investopedia.com/terms/n/nso.asp). There are no tax consequences of any kind on either the grant date or when they are vested. Participants must recognize ordinary income on the spread when they exercise the SARs. Most employers will also withhold supplemental [federal income tax](https://www.investopedia.com/terms/f/federal_income_tax.asp). Furthermore, they will hold back funds to pay state and local taxes where applicable.

Many employers withhold taxes on SARs by using shares. For example, an employer may only give a certain number of shares and withhold the remainder to cover the tax. As with NSOs, the amount of income recognized upon exercise becomes the [cost basis](https://www.investopedia.com/terms/c/costbasis.asp) for taxes when holders sell the shares.

## Important Considerations for Stock Appreciation Rights

SARs are similar in some ways to [phantom stock](https://www.investopedia.com/terms/p/phantomstock.asp). The major difference is that phantom stocks are typically reflective of stock splits and dividends. Phantom stock promises employees the value of company shares or the stock price increase over a period. The phantom stock bonus an employee receives is taxed as ordinary income at the time it is received. Phantom stock is not tax-qualified, so it does not have to follow the rules that [employee stock ownership plans (ESOPs)](https://www.investopedia.com/terms/e/esop.asp) and [401(k)s](https://www.investopedia.com/terms/1/401kplan.asp) must follow.

## Pros and Cons of Stock Appreciation Rights (SARs)

The greatest advantage of SARs is flexibility. Companies can structure SARs in various ways that work best for different individuals. However, this flexibility requires making numerous choices. Companies must decide who gets SARs, their value, liquidity, and the vesting rules.

Employers like SARs because the accounting rules for them are more favorable than in the past. They receive fixed instead of variable accounting treatment, much like conventional stock option plans. However, SARs require the issuance of fewer shares and dilute the share price less than traditional stock plans. Like all other forms of [equity compensation](https://www.investopedia.com/terms/e/equity-compensation.asp), SARs can also serve to motivate and retain employees.

> **Important**
>
> Despite their many benefits, SARs are a high-risk form of employee compensation. If the company's stock does not appreciate, SARs often expire worthless.

## Practical Example of Stock Appreciation Rights (SARs)

Consider an employee who earns 200 SARs as a performance bonus. Furthermore, suppose that the SARs mature after a period of two years. The stock of the company then proceeds to increase by $35 a share over those two years. The result is that the employee receives $7,000 (200 SARs x $35 = $7,000) in additional compensation. These SARs could also have a clawback provision where employees lose them if they leave the company before the two-year period ends.

## The Bottom Line

Stock Appreciation Rights (SARs) provide employees with a way to benefit from a company's stock price increase without purchasing stock. They offer advantages such as potential profit without an exercise price and favorable tax treatment similar to non-qualified stock options. However, they are high-risk; if the stock price doesn't appreciate, SARs may be worthless. Additionally, employers benefit from SARs by motivating employees without diluting share prices.

Consider the vesting schedules and clawback provisions when dealing with SARs, as they can affect your potential returns. Understanding these aspects can help both employees and employers make informed decisions around their compensation strategies.

> **Article Sources**
>
> 1.  Fidelity. "[About Stock Appreciation Rights (SARS)](https://www.fidelity.com/products/stockoptions/aboutsar.shtml)."
>     
> 2.  Internal Revenue Service. "[Publication 17, Your Federal Income Tax](https://www.irs.gov/pub/irs-pdf/p17.pdf)," Pages 15-16.
>     
> 3.  Internal Revenue Service. "[Publication 15, Employer' s Tax Guide](https://www.irs.gov/pub/irs-pdf/p15.pdf)," Page 39.
>     
> 4.  Internal Revenue Service. "[Publication 525, Taxable and Nontaxable Income](https://www.irs.gov/pub/irs-pdf/p525.pdf)," Page 5.
>     
> 5.  Internal Revenue Service. "[Publication 17, Your Federal Income Tax](https://www.irs.gov/pub/irs-pdf/p17.pdf)," Page 51.
>     
> 6.  National Center for Employee Ownership. "[Phantom Stock and Stock Appreciation Rights (SARs)](https://www.nceo.org/articles/phantom-stock-appreciation-rights-sars)."
>     
> 7.  Internal Revenue Service. "[Nonqualified Deferred Compensation Audit Techniques Guide](https://www.irs.gov/businesses/corporations/nonqualified-deferred-compensation-audit-techniques-guide)."