Stock options can leave you with a nasty tax bill

I talked briefly about exercising options above. What if you leave? Performance-Based Equity Compensation Provides the insight needed to create and manage a successful performance equity program. How Employee Stock Options Work Although the particulars vary from one form of stock compensation to another, the basic idea behind most forms is to provide workers with the means to buy company stock which they can then sell. The Stock Options Book A comprehensive guide to employee stock options, with extensive technical details. Thank you again for your help!! The more likely that the company will be sold at a price low enough that the investors benefit from their preference the greater the difference between the value of the preferred shares and the common shares.

The receipt of the premium has no tax consequences for you, the option writer, until the option: (1) expires unexercised, (2) is exercised or (3) is offset in a “closing transaction” (explained below).

Information Menu

On this date, the employer no longer reserves the right for its employee to purchase company stock under the terms of the agreement. An employee stock option is granted at a specific price, known as the exercise price.

It is the price per share that an employee must pay to exercise his or her options. The exercise price is important because it is used to determine the gain, also called the bargain element, and the tax payable on the contract.

The bargain element is calculated by subtracting the exercise price from the market price of the company stock on the date the option is exercised. The Internal Revenue Code also has a set of rules that an owner must obey to avoid paying hefty taxes on his or her contracts. The taxation of stock option contracts depends on the type of option owned. Although the timing of a stock option strategy is important, there are other considerations to be made.

Another key aspect of stock option planning is the effect that these instruments will have on overall asset allocation. For any investment plan to be successful, the assets have to be properly diversified. An employee should be wary of concentrated positions on any company's stock. While you may feel comfortable investing a larger percentage of your portfolio in your own company, it's simply safer to diversify. Conceptually, options are an attractive payment method.

In practice, however, redemption and taxation of these instruments can be quite complicated. Most employees do not understand the tax effects of owning and exercising their options.

As a result, they can be heavily penalized by Uncle Sam and often miss out on some of the money generated by these contracts. Remember that selling your employee stock immediately after exercise will induce the higher short-term capital gains tax. Waiting until the sale qualifies for the lesser long-term capital gains tax can save you hundreds, or even thousands.

What's an Employee Stock Option? Grant Date, Expiration, Vesting and Exercise To begin, employees are typically not granted full ownership of the options on the initiation date of the contract, also know as the grant date. Taxing Employee Stock Options The Internal Revenue Code also has a set of rules that an owner must obey to avoid paying hefty taxes on his or her contracts. For non-qualified stock options NSO: The grant is not a taxable event.

Taxation begins at the time of exercise. The bargain element of a non-qualified stock option is considered "compensation" and is taxed at ordinary income tax rates. The sale of the security triggers another taxable event. If the employee decides to sell the shares immediately or less than a year from exercise , the transaction will be reported as a short-term capital gain or loss and will be subject to tax at ordinary income tax rates.

If the employee decides to sell the shares a year after the exercise, the sale will be reported as a long-term capital gain or loss and the tax will be reduced. I too think that I should have gotten either an approval or decline of my options , neither was delivered to me, hence I believe this is a direct violation of my employment agreement. My options never materialized, I basically got the buying company options at a strike price which is the share price in the day of the buyout which means zero profit!

My guess is that you make some enemies with this post. It is clearly to the advantage of the company that the terms of stock options and vesting periods remain opaque. What if there were liquidity in options? That would be interesting, and wildly dangerous, I imagine, because such liquidity would be so predominantly speculative in the absence of knowledge of company fundamentals.

A successful growing company grants millions of dollars worth of options each year, and I think it works to their advantage to have people understand their value and thus make rational decisions about them. That is certainly the case for well known private companies eg, Facebook , and sometimes is the case for smaller companies as well; question is can you find an investor who wants to buy the shares.

Often this will be restricted for current employees but more open for ex-employees. This can be very complex and the SEC has rules about shareholder counts, how the shares can be offered etc. Hello, I just received an employee stock option that would allow me to buy shares within five years.

Do I have to buy the shares right away? If I buy the shares now and after 2 years I left the company or they fired me, do I still have the right for my shares?

I really appreciate your advice. Really sorry for the delayed reply. Usually you have all 5 years. Usually you can buy some now and some later.

Tax issues vary, research them carefully. Well written for sure. A small company was bought by a larger one and the employee was given her recalculated options. There are 2 years left on this employees vesting schedule. Without any prior negotiation at time of hire regarding acceleration of vesting, is there any way receive acceleration in case of termination? That means that their employer is under no obligation to keep them employed until the end of their vesting period or for any other reason.

They can be fired because of a lack of work for them to do, a desire to hire someone less expensive to do the same job, a desire to restructure and eliminate their job, or because the company is unsatisfied with their work. By treating the terminated employees nicely, the remaining employees are less likely to panic.

Normally one should expect to vest only as long as their employment continues. How do unvested options work post-IPO? Is an IPO an event that can trigger acceleration, or is this reserved for acquisition typically? Can unvested shares be canceled post-IPO? It is very unusual for an IPO to trigger acceleration.

While it is easy to see an IPO as a destination for a startup, it is really the beginning of a much longer journey. An IPO means that a company is ready to have a broader base of shareholders — but it needs to continue to deliver to those shareholders, thus it needs to continue to retain its employees.

Occasionally companies will give people the option to stay for reduced option grants but that is unusual. Family businesses and business that exist outside that ecosystem of startup investors, lawyers, etc may have different arrangements.

What happens if you exercise pre-IPO stock options within 90 days of quitting and the company never goes public? Then you own shares that may be hard to sell. The company may be acquired and you might grt something for your shares, or in some circumsances you can sell shares of private companies.

But the money you pay to exercise the shares is at risk. This entire article and your answer to my question has been the best write up on this topic that I could find on the Internet.

I received the agreement, signed it, and got a copy of it back signed by the corporate secretary. I never received any other documentation since. Should I contact HR or a financial advisor? Just slightly concerned since the company seems a little secretive to me. I have been with them for over 6 years. Usually you have 90 days after leaving until you have to exercise the options, but this varies from plan to plan and the details should be in the paperwork you signed.

One data point that you will need to finalize your decision is the FMV fair market value of the shares for tax purposes. The company should be willing to tell you this; if it is quite a bit more than a penny some taxes will be due on exercise but the shares are more likely to be worth something. Thanks Max, I really appreciate it. After reading your article and doing some research I found out I was looking at the par value, not the exercise price. So in my case, I would be severely underwater.

Thanks again for sharing your knowledge! Max, thanks for the great info. I am considering joining a tech startup and wonder if there are enough benefits for both the company and myself for me to be brought on as an independent contractor vs.

Any info you have or can refer me to would be helpful. Sorry for the delay. But even then, you will probably not get benefits or stock options. Good luck with your decision. The terms of preferred stock vary, not only from company to company but also across different series of preferred stock in a company.

I may not have time to answer but feel free to try me first initial last name at gmail. Hi Max — thanks for the insightful article. Half of my stock options have vested. I got them at a price of 3 and the current valuation is now at 4.

Do I get to leave with my vested as of departure date options or do I need to pay the company to buy them at the granted strike PLUS pay the tax on the gains etc. Putting aside any idiosyncrasies of your specific options agreement, typically you have 90 days after departure to exercise. So within that 90 days you need to pay the strike price and you incur a tax liability. Keep in mind the stock could decline before you can sell, so its not just acash flow exposure, you may wind up selling for less than you paid to exercise.

Thanks for the help! Question — I purchased stock and then my company got purchased. My understanding is that the main investors lost money on their sale they sold below what they put into the company. Do you have any experience with seeing employees receive additional option grants with promotions? Is this common or only at key-level positions? I joined the sales team of a person startup at an entry level position about 2 years ago.

Is it reasonable to ask? It is common but not universal to receive additional grants with significant promotions, but there is wide variety in how these are handled: I would ask your employer what the process is to ensure that your stock is commensurate with your current contribution to the company.

For example, if when you joined an entry level employee received shares and an account exec received , but today an entry level employee receives shares and an account exec receives If this is the case, many companies would not give you additional shares to go with the promotion but would increase your salary.

While this example may sound exaggerated, if the company has twice as many employees, grants may be half the size per employee — often the board will think about how much stock should go to all employees as a whole per year, and now there are twice as many to share the same number of shares.

In any case whatever that value is, is it fair compensation for your time? How long do you have to stay to vest the options? And how much work are you expected to do? How does your stake compare to other participants and their contribution? I need your help!

My company is a Green Sustainable clothes recycling company.. I think 4 years is most common, maybe 5 next most, years is unusual. I am not sure what else you are asking. If you are asking about taxes on the equity, if it is options there is typically no tax on vesting if the plan is set up properly which will almost certainly require an attorney.

How often should a company revalue their privatly held stock options? Any guidelines around that in the accounting standards? I am not a tax lawyer but I think for tax purposes the valuations are good for a year.

If things change eg, financing, offer to buy the company, or other significant events you may want to do it more frequently, and for rapidly growing companies that might go public soon you may want to do it more frequently. With startups becoming a global tendency, it becomes complicated to create one model that fits all. Any thoughts on adjusting vesting schedules, cliff periods and accelerations to ventures occurring in high-risk geographical areas?

One thing that I do see adjusted globally is some of the details to fit local tax laws — even US-based companies have to administer their plans differently in different jurisdictions.

Maybe a reader knows?? Great article, now for my question. Been working for a company 3 years, been vested, for example, , shares, at 5 cents a share. Leaving company, It looks like the period to exerci se, buying the shares will have about 7 more years.

When I leave, how long does one usually, have to buy the shares, if they choose. I am a little confused about the 90days mentioned ealier in the article.

Usually the option period is 10 years but only while you are employed. When you leave, the unvestef options go away and you have 90 days to exercise the vested options. Of course it depends on your specific option plan which may be completely different. I have some vested preferred shares.

What are my options to liquidate them before any event? Your option may be to find someone who wants to buy the stock in a private transaction with limited data. Or it may be that the company has to give permission even if you find a buyer.

Trading private stock is difficult. Also if you have options, typically you will have to exercise them before you can sell them. These stock options shall be deemed to have been granted January 31, and shall have a term of 3 years from the effective date granted. These stock options shall remain vested for a period of 24 months in which Employee remains in his current position with the Company. It sounds like you have between 2 and 3 years in which to exercise them. The vesting language is a bit unclear to me.

You may want to get some legal advice, I cannot interpret that clearly. Let me elaborate on this as I am in the middle of an asset acquisition a division of the company is being bought that will close on Jan 31, I am still trying to understand the language above and below and what my options will be once the transaction is complete.

The strike price above given seems a bit high. How does this work in terms of an asset being acquired as opposed to the entire company? As Twitter is going public soon and I am in the last round of interview. If they offer me a job, will there be any impact to my equity offering if I join before they go IPO or will it be the same after they go IPO?

Which will be most beneficiary to me? Typically people expect the price to increase on I and thus try to get in prior. Predicting what actually happens is hard,for example Facebook went down. But generally joining before IPO is viewed as a better bet.

On the day of my 7hrs in person interview conclusion, HR mentioned that they are not the highest paid company around, they come in like 60th percentile… But their RSU are at great offer. I have been offered just over shares for. Our company is expecting to be acquired in the next 90 days so I could end up with no vested options… What happens if we get acquired before I am vested? The other thing that complicates it is that our company has a few different products we offer and the one that is getting acquired is the one I work on..

Does this make sense? Typically if the acquiring company does not want to keep you they can terminate you and your unvested options will not vest. If they want to keep you they would typically exchange your options for options in the new company.

They will have some discretion in how to do this. Hopefully they will want to keep you and will treat you well. Now after 6 months the company is acquired by another company for cash buyout. Since I exercised my stock options just 4 months ago, will I be not considered for Long term Capital gain taxes?

Or can I hold on to my share certificates for 9 more months and then will I eligible for Long term capital gain tax rate? Check with an attorney to be sure, it could depend on the details of that specific transaction but usually they close faster than that. We received an initial payout and had a subsequent release of the escrow amount withheld. This escrow payout was received over 1 year after the sale of the company. What is this payout considered?

Is it a long term capital gains? Also, what about a milestone payout that falls under similar circumstance? I am not a tax attorney so I am not sure. If it came through regular payroll as a bonus my guess is that it is not long term capital gains.

Hi Max — Great article! I have a question. I joined a company as one of the first 3 sales directors hired and was told in my offer letter I have , stock options pending board approval.

I have now been working for the company for 18 months and have not received any documentation regarding my options.

I am continually told that they will be approved at the next board meeting but that has not happened and I was recently told they would be approved after the next round of funding but that did not happen either. What is happening here and what is your recommendation? Thank you in advance for your assistance. Something is not right. Sometimes the approval will be left out of a board meeting. With really bad luck you could be skipped twice.

There is no good explanation for 18 months. But something is wrong with your company and I would be looking hard for something new. Sorry to be the bearer of bad news. If the CEO has an explanation that really makes sense feel free to share it and I will let you know what I think, maybe I have missed an innocent explanation but this does not sound right. Thanks so much for confirming what I was thinking, Max.

To my knowledge the board has met several times and our CEO repeatedly states the valuation of our company is going up so I have not heard about a down round. We have had the same original investors for a few years and have recently had a new influx of cash in the form of loan but are still seeking that outside VC investment. I may have another start up offer coming soon and this information will help when I make the decision whether to accept the new position.

Thank you again for your help!! You are commenting using your WordPress. You are commenting using your Twitter account. You are commenting using your Facebook account. Notify me of new comments via email. Enter your email address to subscribe to this blog and receive notifications of new posts by email. Max Schireson's blog Thoughts on technology and the tech business. Vesting There is a small but necessary catch: Ownership percentage This brings us to the number which is much more important though it is less impressive sounding than the number of shares — what portion of the company do you own.

Exercise I talked briefly about exercising options above. Classes of stock Most startups have both common and preferred shares. How much are they worth That is, of course, the big question. Expiration and termination Options typically expire after 10 years, which means that at that time they need to be exercised or they become worthless.

How many should you get How many stock options you should get is largely determined by the market and varies quite a bit from position to position.

This varies by job level: Taxes Taxes on stock options are complex. What happens to my options if the company is bought or goes public? Max Schireson on August 23, PM on August 25, Max Schireson on August 31, What happens if the company is bought before I was granted my options? In my employment agreement the granting is subject to board approval and that never happened.

Max Schireson on September 15, Max Schireson on September 16, I am assuming your options dated from joining full time, so it was a 6 month delay, not a year? Max Schireson on September 18, Benny on November 6, Max Schireson on May 17, How much would you pay to own an undisclosed percentage of my house? DMill-Tech on April 10, Martha on April 28, Max Schireson on April 28, Unfortunately for the subject of your story, probably not.

CF73 on May 16, V on June 14, Max Schireson on June 14,

Help Menu Mobile

The taxation of stock option contracts depends on the type of option owned. For non-qualified stock options (NSO): The grant is not a taxable event. Taxation begins at the time of exercise. The bargain element of a non-qualified stock option is considered "compensation" and is . Basics of Employee Stock Options and How to Exercise Them An employee stock option (ESO) is a privately awarded call option, given to corporate employees as an incentive for improving a company’s market value, which cannot be traded on the open market. Jan 31,  · Nonstatutory Stock Options. If your employer grants you a nonstatutory stock option, the amount of income to include and the time to include it depends on whether the fair market value of the option can be readily determined.