HANDLE YOUR STOCK OPTIONS RIGHT
There are two types of stock options, with varying rules and tax issues: Incentive stock options and non-qualified stock options:
An ISO has no tax liability when you exercise the options and hold the stock, until you declare a non-sale disqualifying disposition or sell the shares. In the event you sell the stock, the difference between the amount you paid and receive from the transaction is taxed as capital gains income or loss. If you sell the stocks in less than 12 months, you will incur taxable income that is subject to local, state, federal, and social security taxes. On the other hand, ISO shares must be held for at least one year and a day from the date of exercise to claim the long-term capital gains treatment.
When exercising an NSO, you can be taxed at any rate: at time of exercise and sale of the shares. You will pay an ordinary income tax in any gain made at the time the option is exercised. Conversely, you will pay capital gains tax on any further appreciation if you own the stock and sell it at some point. The long-term capital gains treatment is only applicable if the share is held for over a year from the day of exercise.
Here’s what you can do in case you possess stock options:
- Cashless hold - Exercise sufficient options to obtain the remaining shares without paying additional cash. That way you get to exercise and sell enough shares simultaneously to cover taxes and the cost of exercising such options. The remaining shares and fractional shares will be paid in cash.
- Cashless exercise - Exercise vested options at a preset expiration or price. Options are exercised and stocks are sold right away without paying any additional costs. The net proceeds are deposited into your account days following the transaction.
- Setting the timing for exercising options - This will help you manage taxes. Most firms withhold some taxes when options are exercised. When using this technique, make sure to place stop orders in case the stock price declines. It will be taxed as ordinary income, but you won’t be paying for other fees.
- Formulating a plan for exercising options - Come up with a plan to monitor the underlying stock’s price and process vested in-the-money options before its expiration or at a determined target price to reap the gain. Continue exercising more option if the stock price continues to surge.
- Stock swap - The exercise is financed using company shares you already hold. A tax-deferred strategy, you relinquish adequate stocks to equate the price of the options you intend to exercise. The holding period and cost basis in the previous stocks are carried over to the new ones. Any additional bargain would be a taxable income, averting any tax liability on the old stocks’ unrealized appreciation until it is eventually sold. Also, you need not to provide more capital to exercise the options.
- Disqualifying position - Consider this only if you have already exercised ISOs and the stock price slumps. This move disqualifies the ISOs from securing a tax treatment, which takes effect after exercising the option by selling the shares before holding period prerequisites. Aside from that, a purposive disqualifying disposition could be utilized if ISOs were facilitated and the stock’s price plummeted before selling the shares. It would be taxed as ordinary income.
- Gifting NSOs - Giving an NSO is not considered a gift until the options vest. The recipient of this option is liable for any income taxes due on bargain element, allowing you to scrap the option’s value from your estate and transfer the future gain to others.
- Making an 83(b) election - Before vesting, exercise the options. The bargain element is charged as if the options were vested. Any increment is taxed at capital gain rates upon vesting the options and fulfilling holding period requirements. Even though the options have been exercised, the owner has no full control until these are fully vested.
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