Does this sound like you? You work for a company that is in an aggressive growth stage. Your employer recognizes the need to retain key employees. So, the company puts an incentive stock option program in place. You get a letter from the human resources department announcing this great new employee benefit and, of course, you enroll. Now what?
Employee Stock Options can be worth a lot of money to you. They also create the most complicated tax issues you can have.
Imagine yourself as an employee of ABC Systems Development Inc. You have a letter telling you that you have the right to purchase 1000 shares of your company’s stock for $3.00 a share on July 1, 1999. You will purchase this stock directly from your employer. As July 1st approaches, you watch the stock price of your company on a daily basis. On some good news from the analysts that watch your company, ABC Systems Development’s stock climbs to a market price of $30.00 per share. The stock is worth ten times the amount at which you are able to buy it. Should you exercise the option to buy the stock? Should you simply hold the option until it is closer to expiration? If you exercise, then what? Should you hold the stock, or sell it right away? What about THE TAX CONSEQUENCES?
We have reviewed many of these situations for our clients, and find that the company stock options that our clients hold represent a significant part of their net worth. Therefore, the decisions that have to be made are very important and can greatly effect the amount of money you keep after the company stock is finally sold and the income taxes are paid. There are a number of details and planning strategies that we have helped our clients step through. The tax issues revolve around the capital gains tax rates, the alternative minimum tax system and your marginal income tax bracket. The details are too complicated to explain in a short article, but we have listed the significant questions here.
- What kind of stock options do you have? What is the difference between the two basic types of options?
- Should you exercise your stock options as soon as you are vested?
- Once you have exercised the options to buy the stock, how long should you hold onto the stock?
- Exactly what are the income tax consequences and how bad can the taxes be?
- Should you be concerned about qualifying the sale of this stock for long term capital gains treatment and be taxed at a maximum tax rate of 20%?
- What is the alternative minimum tax system and why should you be concerned about it?
Tax planning on stock options can save thousands of tax dollars over several years. We have found that the seemingly obvious answers are not always the best answers. In some cases, the exercise and sale of your company stock might be connected with your imminent retirement or with job change. Planning opportunities abound when there is a shift in income during one of these transitional periods.
As always, we are here to help you step through these transactions and to illustrate the best tax savings strategies when you sell your company stock options.