I'm going to focus on Nonqualified Stock Options (NSO) because that's all I have. There are also Incentive Stock Options (ISO), but since I've never received any of them, I'm not sure exactly what the differences maybe. There are tons of articles out there are discuss the pros and cons of each.
ISOs:
"Incentive stock options granted by your company give you the right to purchase a specific number of shares of company stock at a specified price (grant price) for a predetermined period of time. Your incentive stock options are subject to special tax treatment when you exercise them and could subject you to the alternative minimum tax."
NSOs:
"Nonqualified stock options granted by your company give you the right to purchase a specific number of shares of company stock at a specified price (grant price) for a predetermined period of time. The exercise of nonqualified stock options is a taxable event regardless of whether you sell your shares or hold them."
But basically it seems to come down to NSOs being a lot less of a tax headache than ISOs.
"Nonqualified options have two disadvantages compared to incentive stock options. One is that you have to report taxable income at the time you exercise the option to buy stock, and the other is that the income is treated as compensation, which is taxed at higher rates than long-term capital gains. Incentive stock options provide a way to avoid both of those disadvantages. There's no income to report at the time you exercise the option (unless you sell the stock at the same time you buy it). And if you hold the stock long enough to satisfy a special holding period, your gain from the stock will be treated as long-term capital gain.
These tax advantages are partly offset by the alternative minimum tax (AMT). This is a complicated calculation that may cause you to pay tax at the time you exercise an ISO. But the amount of AMT you pay is less than the tax you would have paid if you exercised a nonqualified option — and you may be able to recover much or all of the your AMT payment by claiming an AMT credit in future years."
So, I have some options to exercise...when should I do it?
I've come down to the philosophy that because I already have so much invested in my company through the Employee Stock Purchase Plan, I don't want to invest any more than I already am. So, I excerise as soon as I'm eligible to do so.
My belief is that I can take that money and put it into some other investments, thereby diversifying my investments.
There are some considerations that I would ask myself. For example, do I see myself being in a lower tax bracket while I'm still eligible to expense my options? If so, it may be better to hold off. Are the stocks temporarily depressed for some reason? If so, then you could consider holding off, but even then, excersizing might make sense since the gain could be used towards other investments.
Paranoid Brain has a post on options as well.
Tuesday, July 11, 2006
When To Exercise Stock Options?
I'm going to focus on Nonqualified Stock Options (NSO) because that's all I have. There are also Incentive Stock Options (ISO), but since I've never received any of them, I'm not sure exactly what the differences maybe. There are tons of articles out there are discuss the pros and cons of each.
ISOs:
"Incentive stock options granted by your company give you the right to purchase a specific number of shares of company stock at a specified price (grant price) for a predetermined period of time. Your incentive stock options are subject to special tax treatment when you exercise them and could subject you to the alternative minimum tax."
NSOs:
"Nonqualified stock options granted by your company give you the right to purchase a specific number of shares of company stock at a specified price (grant price) for a predetermined period of time. The exercise of nonqualified stock options is a taxable event regardless of whether you sell your shares or hold them."
But basically it seems to come down to NSOs being a lot less of a tax headache than ISOs.
"Nonqualified options have two disadvantages compared to incentive stock options. One is that you have to report taxable income at the time you exercise the option to buy stock, and the other is that the income is treated as compensation, which is taxed at higher rates than long-term capital gains. Incentive stock options provide a way to avoid both of those disadvantages. There's no income to report at the time you exercise the option (unless you sell the stock at the same time you buy it). And if you hold the stock long enough to satisfy a special holding period, your gain from the stock will be treated as long-term capital gain.
These tax advantages are partly offset by the alternative minimum tax (AMT). This is a complicated calculation that may cause you to pay tax at the time you exercise an ISO. But the amount of AMT you pay is less than the tax you would have paid if you exercised a nonqualified option — and you may be able to recover much or all of the your AMT payment by claiming an AMT credit in future years."
So, I have some options to exercise...when should I do it?
I've come down to the philosophy that because I already have so much invested in my company through the Employee Stock Purchase Plan, I don't want to invest any more than I already am. So, I excerise as soon as I'm eligible to do so.
My belief is that I can take that money and put it into some other investments, thereby diversifying my investments.
There are some considerations that I would ask myself. For example, do I see myself being in a lower tax bracket while I'm still eligible to expense my options? If so, it may be better to hold off. Are the stocks temporarily depressed for some reason? If so, then you could consider holding off, but even then, excersizing might make sense since the gain could be used towards other investments.
Paranoid Brain has a post on options as well.
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2 comments:
I got NSO's at my last company. Base rules I've learned from my experience and that of family and friends:
1) Exercise as early as possible to start the long-term capital gains clock running, if those count.
2) Talk to someone about the 83b thingy. It's something that relates to AMT. I don't make enough and my stock options weren't valuable enough for this to be a factor, but do talk someone about this paperwork if you have options.
3) Depending on what your stock grant, etc, you might have to pay taxes on your dividends. If you are lucky, they will be unqualified and you can take them as straight dividend income. Check with the IRS for more info on this.
4) Consider whether or not you think these options will be worth anything in the future. If you don't think the company will go public during the time you are there, don't consider options anything but more paperwork to sign. If you're close to the $50 million annual revenue mark, then your firm might actually go public and be worth something.
5) Find out how many shares are available. Often a company that's going to IPO has to split their stock several times to make enough shares to sell on the market. That could make your $1.00 shares turn into 5 $0.20 shares which could lower your share price for selling in the future, etc. This is very important because some companies do additional rounds of financing and watch their pre-IPO stock valuation change, quite profitably.
I could go on and on, but I'll just stop now. If someone wants me to write more, just leave a comment on my blog.
Thanks FF!
Mapgirl, wow...good info! I've never had IPO stock options, but if you get into a solid company (ie Google), it must be pretty exciting!
One word of caution on bullet number one, "1) Exercise as early as possible to start the long-term capital gains clock running, if those count."
I know this eliminates the whole long-term capital gains choice, but I want to put caution in exercising your options without going a cashless route, only because you could end up paying dearly for stocks that could tank. I always expense stocks via a cashless method, either for money upfront or stocks purchased with the difference. I guess you could go the route of buying the stocks outright, but if you're already heavily invested in your company by working there and maybe employee stock purchase plans, be sure to weigh your options... :) just in case.
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