| Understanding employee stock options |
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There is a way out of this mess. Sell the stock by
Dec. 31 of the year in which you exercise the options and you'll
pay ordinary tax on the actual gain.
"After that, the AMT is written
in stone," says Thomas, "and it's no longer possible to
do anything."
That's why many tax experts recommend that employees
exercise ISOs early in the year if possible. The ISO-AMT trap springs
shut on the last day of the year. If you exercise an option in July
2006 and have a large amount of profit built in, you need to make
a "hold or sell" decision by Dec. 31 even though it's
impossible to know whether the stock price will tank during the
first seven months of 2007 or continue to rise. Exercise your shares
in January or February and there's a much smaller window of uncertainty.
Also, not everyone will owe AMT just because they
exercise incentive stock options. Bankrate's article, "Beware
the complicated and costly AMT," can help you understand
much more about the AMT. Generally, people who make less than $75,000
don't get nipped by the AMT unless they have a large number of personal
exemptions or itemized deductions, incentive stock options or they
live in high-tax states such as New York and California.
"But that doesn't mean you need $75,000 in ISOs
to trigger it. If you're on the borderline of paying AMT before
exercising ISOs, the first dollar of ISO income will trigger AMT,"
Thomas says.
Perhaps the toughest decision facing employees who
have stock options is determining when to sell and when to hold,
says Rosen of NCEO.
"Historically, most who receive ISOs don't hold
long enough to qualify them as ISOs. Most people don't take a risk.
They have a strong preference for current income. Some are making
a mistake; they should hold the stock.
"There isn't a per se best advice, because it
depends on a whole raft of circumstances. How risk averse are you?
If you're looking at options that have gained a lot in value and
represent 1 percent of your net worth there's no problem taking
a risk. But if the options represent 50 percent of your net worth,
how much do you want to gamble to get the 15 percent tax instead
of your ordinary tax rate?"
Thomas adds that it's a mistake to think that the
right solution is all or nothing. Analyze your risk, and usually,
the best thing is to take some money off the table.
"Always make sure that you have enough money
set aside to pay the tax, and if it means selling some stock, sell
it instead of taking the risk that you won't have the money needed
to pay the tax. Secondly, when people hear about the risk aspect
of the AMT they throw up their hands and say, 'Forget it, I won't
hold any shares.' They sell right away and that's something you
should only do in a situation of high risk. If you can take some
risk, the tax benefit can be a very good deal for part of the stock."
Remember, if your stock options are a significant
portion of your net worth, consider consulting a tax specialist
regarding the best way to keep the most money in your pocket.
Up next: "Ways
to exercise employee stock options."
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