| Understanding employee stock options |
| By Laura
Bruce • Bankrate.com |
|
If you check your company's stock
price every day, chances are you have employee stock options. Stock
options can fatten your net worth, but getting them from the company
and into your possession, and then figuring out the best, most tax-efficient
way to cash them, isn't always a smooth ride.
If "employee stock options" is a relatively
new subject for you, we'll explain some of the ins and outs. These
are the basics; many people who receive options should consult an
accountant or tax attorney to determine the best route to take.
Options often involve a lot of money -- spending a couple hundred
dollars on a consultation could help you save thousands.
An option gives you the right to buy a certain number
of shares of company stock at a specified price, called the exercise
or strike priceStrike price
It's the price of the stock on the day the company grants the option. Also called exercise or grant price.. Companies grant stock
options in an effort to retain and motivate employees. They are
also used to sweeten the pot for prospective employees.
The two types of options we'll look at are incentive
stock optionsIncentive stock options
Stock options that will receive favorable tax treatment if the employee
holds the shares for at least one year before selling.
, or ISOs, and nonqualifiedNonqualified
Stock options that don't qualify for favorable tax treatment. Taxes
must be paid in the tax year that the options are exercised.
stock options.
"Surveys indicate that ISOs and nonqualifieds
are roughly equal in popularity, but my sense is that companies
are moving toward the nonqualified," says Kaye Thomas, author
of "Consider Your Options: Get the Most From Your Equity Compensation"
and publisher of the online Fairmark.com Tax Guide.
"The main reason is the complexity of ISOs. They
involve the alternative
minimum taxAlternative minimum tax
An IRS method for ensuring that high-income earners pay their fair
share of taxes. It disallows many common deductions. If the amount
of tax owed under the AMT is higher than what's owed under the regular
tax system, the taxpayer pays the AMT., or AMT, and companies
have a hard time explaining it to the rank and file. They may still
give ISOs to executives, but most companies are moving away [from
ISOs] outside of that."
Whether your company grants ISOs or nonqualified stock
options, you'll have to wait to exercise
them. Exercising options is the act of buying the options from the
company and putting them in your name. Usually it involves having
them transferred to a brokerage account.
But before you can exercise your options, the options
must vest. Vesting is the process by
which you, the employee, acquire the rights to exercise the options.
Vesting takes time; you have to stick around as an employee usually
for at least a year after the options are granted. Most companies
allow a percentage of the options to vest after one year and the
remaining options to vest on a regular schedule over the next several
years.
The right to exercise stock options expires after
a certain amount of time. The amount of time you have to exercise
options varies from company to company, but it is often within a
few years after all of the options have vested.
Nonqualified
stock options
Nonqualified stock optionsNonqualified
stock options
Stock options that don't qualify for favorable tax treatment. Taxes
must be paid in the tax year that the options are exercised.
get their name because they don't qualify for special tax treatment.
When you exercise these options you pay ordinary income
tax that year on the bargain elementBargain
element
The difference between the exercise price and the fair market value
of a share of stock the day the options are exercised.
-- the difference between the exercise price and the fair
market valueFair market value
The price of the stock on the day you exercised your options; sometimes
pegged as the price the stock closed at that day. of
the stock the day you exercised the options. The amount of the bargain
element is reported to the Internal Revenue Service as compensation.
This differs from the treatment of ISOs, which we'll look at next.
You don't have to sell the stock when you exercise
the option, but you still have to pay the tax; in fact, your company
will probably withhold it. Any appreciation beyond the fair market
value on the day you exercise the option will qualify for capital
gainsCapital gains
An increase in the price of a share of stock (or any kind of asset)
over and above what you paid for it. tax treatment if
you hold the stock for at least one year. That means you'll pay
the capital gains tax rate, which is currently 15 percent for most
taxpayers, versus paying your ordinary tax rate.
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