Do you have employee stock options? If so, you’re in good company. Businesses love granting their employees stock options because they align the employee’s interests with those of the company. They are becoming so popular that over the past 30 years, the number of people holding stock options has increased about ninefold. (1)
It’s nice to be a recipient of stock options, but their value to you will depend greatly on what you do with them. How do you avoid paying excess taxes? How do you make sure to get all the money available to you? Here are three ways that you can get the most out of your employee stock options.
1. Watch The Taxes
Perhaps the biggest determining factor for the end-value of your stock options is taxes. It’s important to understand how stock options are taxed so that you can minimize your tax liability.
How Stock Options Are Taxed
There are two kinds of stock options, Incentive Stock Options (ISO) and Non-Qualified Stock Options (NSO). Their differences boil down to who can receive them and their tax treatment. When you exercise your NSOs, you pay ordinary income taxes on the difference between the grant price and the fair market value of the stock. When the stocks are sold, you then have to pay either short or long-term capital gains taxes on the gains, depending on how long you held them.
Thanks to the Internal Revenue Code, ISOs get special tax treatment. Exercising an ISO is not a taxable event, unlike with NSOs, though it could trigger the Alternative Minimum Tax. If you sell your shares immediately, you pay regular income taxes on the bargain element. To get the tax breaks, you have to hold on to the shares. Everything (the bargain element and the gains) is taxed at the long-term capital gains rate if you hold the shares for at least a year after exercise and do not sell them for at least two years after the grant date. (2)
When To File An 83(b) Election (3)
It might be a good idea to file an 83(b) election if your company stock is growing steadily. An 83(b) election allows you to pay the income taxes due at the grant date instead of the exercise date.
For example, let’s say you are granted stock options at $15 and the price when you exercise them is $30. With an 83(b) election, you pay income taxes upfront on the $15 cost. Any further gains are taxed as capital gains when the shares are sold. Without the election, you would pay regular income taxes on the $30 price when you exercise the options. The election allows you to pay half as much at the regular income tax rate and push the gains made between granting and exercising into the lower capital gains tax rate.
Filing an 83(b) election can be great if the value of your company stock is increasing steadily. On the other hand, you will be worse off if you file and the prices drop or the company goes out of business.
Taxable Income Smoothing
Another tax consideration is the timing of your taxable events as they relate to employee stock options. Planning for income taxes generated from exercising options ahead of time can be extremely valuable to you. Smoothing taxable income over time to stay out of high marginal tax brackets can save you thousands of dollars in taxes.
2. Get Organized
Most likely, your company has given you a variety of restricted stock and stock options at different times and for different amounts. Vesting dates probably vary between the two, as well as expiration dates. With so many different dates involved, it’s easy to overlook a deadline. So many people miss out on their stock options because they plan to exercise them at the last minute, only to get distracted or simply forget. Not exercising your stock options is akin to throwing money away.
If you want to make the most of your employee stock benefits, you need to get organized. There are strict deadlines if you want to take advantage of some of the tax savings listed above. Having a well-organized system for tracking dates and amounts can save thousands in taxes and prevent you from missing out on expired options.
3. Spread It Around
Employee stock options are an easy way to end up with all of your eggs in the same basket, as the proverb cautions against. Do you really want so much of your financial well being tied up in one company? You should hold no more than 10% of your portfolio in your company’s stocks and options in order to stay properly diversified.
This is important because if your company performs poorly it will depress the stock price and could lead to layoffs as well. There go your portfolio, your income, and your health insurance all at once. Sadly, many people have experienced this. Back in 1999 when Enron filed for bankruptcy, more than $1 billion in employee retirement savings simply evaporated. Many Lehman Brothers employees experienced the same thing as well. (4)
How Can We Help?
It’s important to work with an experienced financial professional in order to get the most out of your employee stock options. At Grace Wealth Management Group, we are well-versed in everything relating to stock options. We can help you minimize taxes, stay on top of dates and deadlines, and diversify your portfolio. When it comes to your employee stock options, there is a lot at stake if you don’t do things right. Don’t try to do it alone. Call us today at (949) 631-3840 or email at firstname.lastname@example.org to set up a complimentary consultation where we can help you figure out how you can get the most out of your employee stock options.
About Jim Peters
Jim Peters is an independent financial advisor and the founder of Grace Wealth Management Group, Inc., a full-service financial firm committed to helping people pursue their financial goals. With more than 24 years of experience in the industry, Jim combines his extensive knowledge with his genuine interest in helping people pursue financial independence. Beyond his experience, he is certified as both a Chartered Life Underwriter® (CLU®) and Chartered Financial Consultant® (ChFC®), meaning he has advanced training and knowledge in financial planning and insurance. Based in Irvine, California, Jim specializes in working with individuals, families, and businesses throughout Orange County. To learn more, connect with Jim onLinkedIn or visitwww.financialadvisorirvine.com.