3 Key Areas to Analyze for your Stock Options, Ep #143

Stock options can be one of the most lucrative benefits of your job, but they can also be a tax land mine.

Our resident tax professional, Will Holt, joins us this week to help you build a framework to consider your company’s stock options.

You’ll learn 3 key strategies you can use to make better decisions for managing your stock option holdings. Including:

    1. Managing the risks and benefits around taxation for 2 types of stock options
    2. Handling the leverage and concentration risk of stock options
    3. Deciding what to do with the proceeds once choosing to exercise and sell

If stock options are one of the perks of your job, you don’t want to get bit by the tax dog, so don’t miss this episode.


What are the risks and benefits of the two primary stock options?

It is important to understand the type of stock options that you have. There are two primary types of company stock options: incentive and non-qualified. The difference between the two is how they are taxed.

Non-qualified stock options have no real risks until they are exercised since they aren’t worth anything until they are above the strike price, or “in the money.” In this case, you’d look to exercise your right to purchase these stock options at the strike price which should be discounted to the current market price of the stock. The shares will also need to be vested in order to do this which typically occurs over a period of time, typically 4 years. If choosing to exercise and not immediately sell, and the stock price is above the strike price, your shares are in the money. If choosing to sell while in the money, any gain would be taxed at ordinary income rates and come through your paystub in most cases.

Incentive stock options alternatively, offer the opportunity for preferential tax treatment compared to non-qualified stock options.  To get preferential long-term capital gains tax treatment on a sale, you must be 2 years from the grant date and 1 year after you’ve exercised. Otherwise known as a qualifying disposition.

The big risk if choosing this strategy is the potential for phantom income to be taxed at AMT rates. Before you reach the 12 month timestamp, the stock price could fall dramatically. If this occurs after the end of the calendar year when the exercise occurred, you would still be responsible for alternative minimum tax due on the ‘bargain element,” the difference between the strike price and fair market value of the stock when exercised. It’s called phantom income, because the income effectively disappears, but the tax remains on gains that are no longer there due to a sinking stock price.

Working with a professional can help you make better decisions

Understanding strategies to unwind your stock options can be complex, which is why it’s helpful to work with a professional. A financial professional can help guide you through the challenging decisions that stock options present. Stock options can be a very valuable part of your net worth and you don’t want to make the wrong moves. Taxes and holding periods aren’t the only challenges that you face by owning stock options; the concentration that you might have can pose further risk.

Are your benefits putting you at risk?

The advantage of having stock options in your benefits package could end up being a sizable risk if not managed properly. You may end up holding a supersized concentration of one stock. Having your net worth tied up in one stock can lead to more risk vs. a diversified portfolio. But many people delay selling because of the potential negative tax impact of selling.

There are ways you can manage these risks. One way is to set target prices to time your exit. You won’t always make the right call, but if you set up a framework to help manage your decisions it can help take the emotions out of the sale. You’ll also want to consider the impact of your stock options on other areas of your financial plan.

What do you do with the proceeds when you have been forced to sell

There may be times when you are forced to sell before you are ready. This could be a large, infrequent income event that could change your tax situation. One of the best ways to see this impact is running a tax projection for the year.

You may be able to take advantage of tax-loss harvesting to offset some of your tax burden. If you are charitably minded, then another way to reduce your tax liability is to set up a donor-advised fund.

In the end, remember that stock options are a reward for your hard work. You don’t want to ignore them or get caught up in analysis paralysis. You can avoid this by building your decision-making framework or working with a financial professional that can help walk you through your choices.

Outline of This Episode

  • [2:14] The difference between incentive and non-qualified stock options
  • [7:40] Your concentration can be another risk
  • [11:35] What do you do with the proceeds when you have been forced to sell
  • [16:36] How are you handling your strategies?

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