Not good.
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But true! She still gets no relief on her original tax bill. I wonder what happens if she never sells her shares?
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- Tax Rates Drive the Decision to Exercise.
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- Tick Tock, the 10-year Expiration of Incentive Stock Options (ISOs).
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Would her tax liability be deferred forever? Again, this is OK. Because of the potential negative impact brought about by acquiring and holding shares, most employees are effectively forced into selling the shares immediately - i. But, can you imagine the impact on a venture company's share price when five or six optionees "dump" hundreds of thousands of shares into the market?
This does nothing to encourage employees to hold company shares. And it can mess up the market for a thinly traded security. From an investor's perspective, there's a huge downside to options, namely dilution.
What Is A Stock Option?
This is significant. From the company's perspective, the routine granting and subsequent exercising of options can quickly compound the outstanding share balance. This gives rise to " market capitalization creep " - a steady rise in value of the company attributable to an increased stock float. Theoretically, share prices should fall slightly as new shares are issued. However, these new shares conveniently get absorbed, especially in hot markets.
As an investor, is it easy to find out what a company's outstanding options are? No, it's not easy and the information isn't updated regularly. The quickest way is to check a company's most recent annual information circular available on www. You should also be able to find out how many options have been granted to insiders from the insider filing reports. However, it's tedious and not always reliable. The belief that options are better than company bonuses because the cash comes from the market, rather than from corporate cash flows, is nonsense.
The long term dilutive effect is far greater, not to mention the negative impact on earnings per share. Annual vesting will ensure that employees who get options do indeed add value. The term optionaire has been used to describe lucky option holders with highly appreciated options. When these optionaires become real millionaires, corporate managers must ask themselves if their payouts are really justified.
Why should a secretary earn a half million dollar bonus just because she had 10, "token" options? What did she risk?
And what about those instantly rich millionaire managers who decide to make a lifestyle change and quit their jobs? Is this fair to investors? Stock option rules, regulations and the taxation issues that arise are very complex. But stock option plans are often complex, and the consequences for making a mistake can be substantial. You could face a large, unexpected tax bill, take on unnecessary risk, or lose the right to exercise your options entirely.
Stock options are more risky than common stock. And yet, when it comes time to diversify by selling company stock, some people choose to hold on to the riskier options over regular common stock. While options carry significant upside leverage, remember that they are a use-it-or-lose-it proposition.
Learn About Incentive Stock Options and the Taxes
Company stock can recover over time. Company stock options are also subjected to different tax rules. Stocks held for more than a year will be subjected to lower capital gains tax. But depending on the type of option, you could pay ordinary income tax, alternative minimum tax, or capital gains rates. Common shares also may pay a dividend, whereas options never will. Many employees simply believe that their company stock will perpetually increase in value, so they wait until the last minute to exercise their options to make the most off the option.
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This wait-until-later approach can be a bad idea. Also consider the tax implications of your decision as well. Exercising your options is a taxable event. If you can create a plan to exercise when you are in a lower tax bracket, you might make more money in the end. Your company can change the terms of your options. Also, for an employee to retain the special ISO tax benefits after leaving the company, the ISOs must be exercised within three months after the date of employment termination.
After you exercise ISOs, if you hold the acquired shares for more than two years from the date of grant and more than one year from the date of exercise, you incur favorable long-term capital gains tax rather than ordinary income tax on all appreciation over the exercise price.
However, the paper gains on shares acquired from ISOs and held beyond the calendar year of exercise can subject you to the alternative minimum tax AMT. This can be problematic if you are hit with the AMT on theoretical gains but the company's stock price then plummets, leaving you with a big tax bill on income that has evaporated. Stock option taxation is an important subject for all optionholders to understand. Now that you know the basic workings of stock options, you should learn the details of their tax treatment.
For international employees, the Global Tax Guide has information on the tax treatment of stock options and other types of equity compensation in many different countries. Matt Simon is one of the writers and editors at myStockOptions. Need a financial, tax, or legal advisor? Search AdvisorFind from myStockOptions.
Incentive Stock Options (ISOs)
Tax errors can be costly! Don't draw unwanted attention from the IRS. Our Tax Center explains and illustrates the tax rules for sales of company stock, W-2s, withholding, estimated taxes, AMT, and more. Podcast included: In addition to this article, this website also has a podcast on stock option basics. See also our brief video on core aspects of stock options. After reading this article, test your knowledge with a fun, interactive quiz on stock options If you are reading this article, your company has probably granted you stock options.
Stock options give you a potential share in the growth of your company's value. An option grant can be set up so that it vests either all at once cliff vesting or in a series of parts over time graded vesting. Stock options become valuable only if the stock price rises, thus creating a discount between the market price and your lower exercise price.
ISO taxation is complex. You must understand how the alternative minimum tax can affect you. Print this article:.