3 Key Areas to Analyze for your Stock Options, Ep #143

Stock options can be one of the most lucrative benefits of your job, but they can also be a tax land mine.

Our resident tax professional, Will Holt, joins us today to help you build a framework to consider your company’s stock options.

You’ll learn strategies that you can use to make better decisions for managing your stock option holdings. If stock options are one of the perks of your jobs you don’t want to get bit by the tax dog, so don’t miss this episode. 

What are the risks and benefits of the two primary stock options?

It is important to understand the type of stock options that you have. There are two primary types of company stock options: incentive and non-qualified. The difference between the two is how they are taxed.

Non-qualified stock options have no real risks until they are exercised since they aren’t worth anything until they are above the strike price, or “in the money.” You can exercise your right to purchase these stock options at the strike price, but they first have to vest over a period of time, typically 4 years. If choosing to exercise and not immediately sell, and the stock price is above the strike price, your shares are in the money. If choosing to sell while in the money, any gain would be taxed at ordinary income rates and come through your paystub in most cases.

Incentive stock options alternatively, offer the opportunity for preferential tax treatment compared to non-qualified stock options.  To get preferential long-term capital gains tax treatment, you must be 2 years from the grant date and 1 year after you've exercised.

The big risk if choosing this avenue is the potential for phantom income to be taxed at AMT rates. This can be created in the year after the stock is exercised. During that 12 month period, the stock price could fall dramatically. If this occurs, you are still responsible for alternative minimum tax due on the 'bargain element," the difference between the strike price and fair market value of the stock when exercised. It's called phantom income, because the income effectively disappears, but the tax remains on income that is no longer there due to a sinking stock price.

Working with a professional can help you make better decisions

Understanding stock options can be complicated which is why it is helpful to work with a professional. A financial professional can help guide you through the challenging decisions that stock options present. Stock options can be a very valuable part of your net worth and you don’t want to make the wrong moves. Taxes and holding periods aren’t the only challenges that you face by owning stock options; the concentration that you might have can pose further risk. 

Are your benefits putting you at risk?

The advantage of having stock options in your benefits package could end up being a risk. You may end up holding a supersized concentration of one stock. Having your net worth tied up in one stock can lead to unnecessary risk. On the other hand, you may end up with a negative tax impact by selling. 

There are ways you can manage these risks. One way is to set target prices to time your exit. You won’t always make the right call, but if you set up a framework to help manage your decisions it can help take the emotions out of the sale. You’ll also want to consider the impact of your stock options on other areas of your financial plan. 

What do you do with the proceeds when you have been forced to sell

There may be times when you are forced to sell before you are ready. This could be a large, infrequent income event that could change your tax situation. To manage that it will be important to run a tax projection for the year. 

You may be able to take advantage of tax-loss harvesting to offset some of your tax burden. If you are charitably minded, then another way to reduce your tax liability is to set up a donor-advised fund. 

It is to remember that your stock options are a reward for your hard work. You don’t want to ignore them or get caught up in analysis paralysis. You can avoid this by building your decision-making framework or working with a financial professional that can help walk you through your choices. 

Outline of This Episode

• [2:14] The difference between incentive and non-qualified stock options 
• [7:40] Your concentration can be another risk
• [11:35] What do you do with the proceeds when you have been forced to sell
• [16:36] How are you handling your strategies?

Resources & People Mentioned

• Tech Worker Stock Options Turn Into Tax Nightmares
• Episode 97 - How to Make Decisions About Your Equity Compensation Plans
• Episode 59 - Tax Solutions for Charitable Giving

Connect With Chad and Will

• https://www.financialsymmetry.com/podcast-archive/ 
• Connect on Twitter @csmithraleigh @TeamFSINC
• Follow Financial Symmetry on Facebook

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