Stock Option Planning

 

In today's workplace, many employees of publicly held companies are receiving stock options as a means of boosting their compensation. The theory being that the companies feel the employees should be rewarded for helping boost the company's stock price. These stock options are given in one of two forms: incentive stock options (ISO) and non-qualified stock options (NQ). In both cases, the employee is granted the "option" to buy the company's stock at a certain price between the day the option is granted (referred to as the "grant date") and an expiration date (normally 10 years after the grant date). In both cases, there is a vesting period of time in which the options will become eligible for exercise. This varies per employer.

 

The price the employee is able to buy the stock at is commonly referred to as the "strike price". The difference between the current stock price and the strike price is referred to as the "bargain element". The tax treatment of the bargain element is different for ISOs vs. NQs.

 

The bargain element is considered an item of adjustment for Alternative Minimum Tax (AMT) purposes and the company cannot deduct the related compensation expense. This will often cause the employee to pay AMT, In addition, the employee is taxed upon the disposition of the stock that was acquired via the exercise. If held for at least one year, the gain is considered a long-term capital gain, not ordinary income. With proper planning, the net tax effect can be controlled and minimized.

 

The bargain element is considered ordinary income on the day of the exercise, regardless of whether or not the employee sells the stock the same day. There are no time restrictions for holding the stock, since ordinary income tax is paid the day of exercise.

 

The choice of when to exercise is a daunting one. When is the right time? What will a person truly walk away with after tax? There are many more questions to be answered if you are going to maximize the benefits of these stock options. Our philosophy revolves around taking the emotions of the situation and looking at the big picture of a client's life. We do this by taking the following steps:

 

Complete a Pre-Model Option Questionnaire that we have created which helps us to assess your personal sentiment towards your company's stock and gather historical data to recreate many of the tax records that most people do not have.

 

Create a model that summarizes the different stock option grants; presents an action plan based on our conversations with you; and calculates the actual AMT, federal, state and payroll tax effects of any of the recommended actions. The right stock option model is constantly enhanced and updated as the need for future transactions come up. We have spent the last 6 years designing our own unique stock option model. Currently, there is no such other model available on the market. Furthermore, we have successfully represented several clients before the IRS in regards to their transactions using this model. Please contact us if you would like to discuss this modeling process further.

 

Take the actions outlined in the model in Step 2. Because of our involvement and understanding of stock options, many of our clients prefer to empower us to execute the transactions at the broker level.

 

Please go to our Financial Planning page to learn how stock options are just a part of the complete financial planning process or contact us for more information.

 

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