The 7 Things You Need To Know About Your Employee Stock Options...
And Where To Find The Answers!
Equity-based compensation can be a powerful vehicle to generate significant personal wealth. It can also be confusing, and may trigger unwelcomed income tax surprises. To successfully capitalize upon your equity compensation, you need to know the answers to the following 7 questions.
1. What kind of “options” do you have?
The term “stock option” is a general, catch-all term people use when referring to their equity-based compensation. However, there are several types of equity awards, and each will have their own specific terms and conditions.
Are yours stock options, restricted stock, restricted stock units, stock appreciation rights or something else? If stock options, are they incentive stock options or non-qualified stock options?
2. When will your equity awards to vest?
Vesting is the process of earning the right to the equity award. Generally, your company will require you to spend a certain number of years working at your company before this occurs. Vesting can happen all at once, or gradually over a number of years, and the number of years it may take to vest can vary by company.
3. What is the exercise price of your options?
The exercise price is what you will pay to purchase the shares at exercise. If the exercise price is higher than the value of the shares, you may not want to exercise. However, if the value of the shares is significantly greater than that exercise price, then your options are “in the money,” and you will want to look at exercising your options.
4. How do you exercise your options?
Exercising means you will convert your options into shares of the company via the agreed upon process. There are a number of different ways to do this, and each way will have its own issues.
One of the most significant issues with respect to exercising is having sufficient available cash to do so. If you do not have enough cash to exercise, there may be alternatives. Make sure you know which ones are available to you?
5. What are the tax implications when you exercise?
Exercising an incentive stock option or non-qualified stock option will likely be a taxable event. However, the income tax treatment between the two may differ significantly. Before you decide to exercise, make sure you understand the income tax implications. Connect with your CPA to discuss, and inquire about doing a detailed income tax projection. It may cost a little money up front, but it will help you avoid any nasty income tax surprises.
6. When do your options expire?
Depending upon the type of award, there are advantages in waiting to exercise your options after they have vested. But do not wait too long. They may expire, and you may forfeit your options altogether.
The company is under no obligation to alert you of the pending expiration, so make sure you create a schedule and track the important expiration dates.
7. Does your company allow for early exercise of options?
Early exercise is a strategy used to mitigate income tax liability related to options. This can be a very risky strategy, but in certain instances, it can be quite effective. When developing a plan for your options, it is important to know if this feature is available.
Where can you find the answers to these questions?
There are two documents that will have the answers to these questions: the company Stock Plan and your individual grant agreement.
The Stock Plan, also called the Equity Incentive Plan, will have all of the general terms and conditions of the company’s equity grants.
The other is your specific grant agreement. While the Company Stock Plan will have the terms of the entire Stock Plan, the grant agreement will delineate the terms of your specific grants.
Between these two documents, you should be able to address most of the questions above. Of course, the tax implications may require the expertise of a CPA. However, before making that appointment, you should be able to answer all of the other questions.
Summary
Employee equity compensation is complicated, but can create significant personal wealth. You should be aware of the important terms and conditions of your equity compensation package, including the 7 questions noted above. Once you have all of this information gathered, you can begin to develop your strategy to maximize your personal wealth and minimize the related income taxes.
If you have any questions on your specific situation, please schedule a complimentary call here.
About the author:
JP Geisbauer is a Certified Public Accountant and a Certified Financial Planner ®. He is the founder of Centerpoint Financial Management, LLC, a retirement planning, investment management, and tax planning firm located in Irvine, CA. If you have specific questions regarding your situation, please schedule a complimentary 30-minute call here.
Disclaimer:
This article is for general information and educational purposes only. Nothing contained in this article constitutes financial, investment, tax, or legal advice. Before taking any action on any topic discussed in this article, please consult with your financial planner, investment advisor, tax professional, and/or attorney for advice on your specific situation.