Many employers will grant company stock options to executives and key employees as a way to incentivize them to remain at a company and tie their incentives to increased production/ profitability of the company. If you have received a stock option from your employer you probably have several questions.
To fully understand your benefit, you need know what is an Incentive Stock Optionsor ISO and what the similarities/ differences between Incentive Stock Options (ISOs)and Non-Qualified Stock Option (NQSOs). This knowledge will help you to identify and better manage your options.
The first and arguably the most important step is determining if your stock option is an “Incentive Stock Option (ISO)” or a “Non-Qualified Stock Option (NQSO)”. Why? Taxes!
Incentive Stock Options allow you to pay Long-term Capital Gain tax instead of Ordinary Income, if you follow certain holding period requirements. If you are a highly compensated employee or executive this can be a huge tax saving for you.
Conversely, if you have a disqualifying distribution (discussed later) on your ISO or you received Non-Qualified Stock Options, they will be taxed at your ordinary income tax rate.
Incentive Stock Options and Non-Qualified Stock Options are much alike in the terms of their structure. Both are issued on a particular date, called grant date. Stock options have another date associated with them called the exercise date. On the exercise date, the employee has the “option” to buy the stock or to let the option expire. Once exercised, the employee owns the company stock and has the choice to sell the stock or hold on to it and sell in the future.
For Incentive Stock Options the time between the grant date and the exercise date is the vesting period. This is the amount of time the employee must hold the option before they can exercise them. Typically, this is 3 yrs. However, other vesting schedules exist and it is important that you check with your company to know what vesting schedule you will be held to. You have 10 yrs. from the exercise date to exercise your Incentive Stock Option. If you wait longer than that the option will expire.
If you have decided to exercise your option the next question you will face is when to sell and what tax implications will apply to your sell.
· If you were granted NQSO the answer is pretty simple. You can sell your stock at any time and you will pay ordinary income tax.
· However, you hold ISOs the answer is complicated by the ability to pay long–term capital gains. In order to qualify to receive this special tax treatment, you will need to follow specific obligations. When you sell your stock it will either be classified as a “Qualifying Disposition” or a “Disqualifying Disposition”
o What is a Disqualifying Disposition? To make this simple a Disqualifying Disposition, of an ISO, “disqualifies” you from receiving the special tax treatment. Meaning you would be paying ordinal income tax.
o You will have Qualifying Disposition if you sell your stock at least 2 yrs. after the option grant date and 1 yr. after you exercised the options. It is important to note that you must satisfy both criteria. If you do, Congratulations! You now have a qualifying disposition and you will be tax at long-term capital gains rate.
The basics are very simple. However, it can become tricky quickly when you begin adding in other conditions executives face such as: to use cash when exercising or using a cashless strategy, working with multiple ISOs with differing exercise dates, you have both Incentive Stock Options and Non-Qualified Stock Options, your ISOs over $100,000, projecting future income to help identify the best time to sell your stock, and other retirement planning questions.
It is important that you ask questions and get help from a financial professional who has knowledge and experience working with executive complex compensation packages.
For more information on executive compensation packages, financial planning, working with a Certified Financial Planner™and help with your personal situation check us out atCastle Wealth Advisors, LLC or talk to your trusted tax/ financial advisor. If you don’t have a trusted advisor, are unsure/ have questions about your executive compensation, and are located in California or Alabama, Castle Wealth Advisors, LLC would be happy to discuss your situation and offer guidance. Check us out to learn more about financial planning and who we are.
This information is general in nature and may be subject to change. Financial professionals and other representatives are not authorized to give legal, tax or accounting advice. Applicable laws and regulations are complex and subject to change. Any tax statements in this material are not intended to suggest the avoidance of U.S. federal, state or local tax penalties. For advice concerning your individual circumstances, consult a professional attorney, tax advisor or accountant.
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