Many publicly traded companies like to take advantage of the growth in their stock by granting stock options to rank-and-file employees along with executives. However, while stock options may be a vehicle to fortunes, those fortunes are often dramatically reduced, if not entirely lost, due to poor understanding by the option holder the employee. Option holders are part of a unique paper society.
Regrettably, this paper is not cash. Transitioning from a "paper society" to the "cash variety" has startling tax consequences, which often leaves the option holder frustrated and aggrieved. Many option holders are unaware how best to exercise their options.
In turn, they overpay their taxes without ever knowing it. Stock options represent a significant untaxed asset.
Proper planning for this eventual tax will save the option holder a bundle. Too often people are not aware exactly which type of options they have. The following explanation will help simplify and clarify the differences between the two. The high tax of the NQSO makes it essentially a traditional annual bonus, only the employee determines when the bonus will be paid. This is true regardless if the employee sells or holds the underlying stock after it is exercised.
Rather than being taxed when exercised, they are taxed when the option holder sells the underlying stock.
If the shares are sold within one year, it is treated as a disqualifying disposition and the gain will be included on the employees W2 as and taxed at the higher rate. Caveat to the option holder: When an ISO is exercised and held, although there is no federal income tax at exercise date, the paper gain at that time is subject to the alternative minimum tax AMT.
Another item to look out for is a mistaken disqualifying disposition of an ISO. Even if the ISO was appropriately held for one year after exercise, it could be taxed at the higher rate.
For example, if an option is granted on January 1st this year, the earliest it can be sold is January 2nd two years later. If these options have accelerated vesting on say June 1st this year, and the option holder exercises them at that time, he must wait until January 2nd year two to sell eighteen months later , not the normal twelve months. After seeing their stocks take a hammering many gulped at my recommendation. Employees with high strike prices face the challenge of coming up with money to pay the strike price.
This is a common error and is referred to as a cashless transaction. An alternative would be a partial cashless transaction whereby 1, options were immediately exercised and sold.
The net cash proceeds from this can be used to exercise and hold the remaining 4, shares. True the 1, shares will be taxed at the high rate but the remaining 4, will not. Other strategies such as exercising prior to April 15th and filing for tax extensions can save big bucks too. A stock option analysis should be performed which measures risk, taxes and internal rate of return.
This provides a platform for a sound strategy and sharp decision-making. The analysis should be periodically updated for new grants, stock splits, re-pricing, etc.
Factors such as trading price, beta and industry must also be considered. The analysis should project forward for a few years and act as a blueprint for an overall option and tax strategy. While the employing company is vital in the option process, it is usually a limited resource for the employee option holder. Finance departments are usually inundated with administering, granting and complying with option regulations, not to mention fielding routine questions from enthusiastic employees.
If outside professional tax assistance is not pursued, option holders may not know of the lurking financial issues they have, much less how to protect themselves.
To be a leader in the "paper society", one must seek expert advanced planning to better protect their future nest eggs and make the best of their already-won victories. Things To Look Out For: Count On Yourself For Leadership: Testimonials "My questions are answered in minutes, taxes are minimized and there are no surprises at tax time for my business or personal taxes.
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