Author Topic: Any experience with stock options?  (Read 6282 times)

sockmunkee

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Any experience with stock options?
« on: October 05, 2012, 01:58:28 PM »
Curious what advice others have on stock options.  Wife is with a tech company where she will be vested in 20,000 shares in about 3 more years.  Company should go public within the next 12 months and is poised to have a solid IPO.  I am of course planning to dump everything into IRAs and I recognize that this involves speculating when the "high" point will be.

Specific questions:
  • What kind of success did you see with your options?  How much did it contribute to your FI?
  • What is the strategy to minimize tax liability?  I have read that you are supposed to exercise them, then wait 2 years to have the lowest capital gains tax.

Any guidance/experience is much appreciated.

kkbmustang

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Re: Any experience with stock options?
« Reply #1 on: October 05, 2012, 02:01:38 PM »
What kind of options are they? Nonqualified stock options or incentive stock options? The answer is critical in determining tax treatment.

sockmunkee

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Re: Any experience with stock options?
« Reply #2 on: October 05, 2012, 03:21:32 PM »
Looks like ISO from her paperwork. 

http://turbotax.intuit.com/tax-tools/tax-tips/Investments-and-Taxes/Incentive-Stock-Options/INF12049.html

Would the grant date be the same as the vesting date in this case?

kkbmustang

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Re: Any experience with stock options?
« Reply #3 on: October 05, 2012, 03:26:59 PM »
No. The grant date is the date they were issued to her. The vesting date is the date they become nonforfeitable (sounds like three year cliff vesting based on your first email). These are the most tax-advantaged form of options. When she exercises them (after they are vested), she won't recognize ordinary income IF the holding period has been satisfied. 

I wrote an article on this (formatting is messed up):

You get more bang for your buck with an ISO. When you exercise an ISO, you do not include the spread in your income. To be able to exclude the spread from your income, you must meet certain holding requirements.

The stock acquired by exercising the option must be held until the later of:

One year following the day the stock was transferred to you on exercise.
Two years after the date the option was granted to you.
If you meet these requirements, when you sell the stock, any gain or loss is taxed as a capital gain or loss rather than ordinary income. This is critical. Ordinary income is almost always taxed at higher rates than capital gain. You want capital gain treatment -- you pay less in taxes and keep more of your money.

If you later sell the stock but you didn't satisfy the holding-period requirements, the gain will be divided into two pieces: The spread will be ordinary income, and the amount over that will be capital gain (just like NSOs). Be diligent in keeping track of the holding period of your ISOs.


kkbmustang

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Re: Any experience with stock options?
« Reply #4 on: October 05, 2012, 03:29:17 PM »
Can you cut and paste the vesting section of the award agreement?

kkbmustang

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Re: Any experience with stock options?
« Reply #5 on: October 05, 2012, 03:31:34 PM »
Also check to see if her options vest on a change in control. (IPO could trigger a change in control provision, thus vesting her sooner than her otherwise set forth vesting schedule.)

sockmunkee

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Re: Any experience with stock options?
« Reply #6 on: October 05, 2012, 10:12:06 PM »
Can you cut and paste the vesting section of the award agreement?

Thank you so much for the advice - reading through this legalese is a bit cumbersome.  The grant date was last December and the Vesting start date was last October.

Vesting:
"the shares subject to this option shall vest and become exercisable over a four-year period, such that one-fourth (1/4th) of the Shares subject o each such option shall become vested and exercisable twelve (12) months after the Vesting Commencement Date, and an additional one-forty-eighth (1/48th) of such shares subject to the option shall become vested and exercisable each month thereafter until all such shares are vested and exercisable, based upon such individual's continued service provider relationship with the Company."

I also found this bit:
"If designated in the Notice of Grant as an Incentive Stock Option ("ISO"), this Option is intended to qualify as an Incentive Stock Option as defined in Section xxx of the Code.  Nevertheless, to the extent that it exceeds the $100,000 rule of Code Section xxx, this Option shall be treated as a Nonstatutory Stock Option ("NSO")

kkbmustang

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Re: Any experience with stock options?
« Reply #7 on: October 05, 2012, 10:51:47 PM »
Okay, so the first tranche vests after one year (5,000 options), and the rest vest monthly over the remaining 36 months. (I'm assuming the 1/48th is a typo since that math doesn't work for a 4 year vesting term. Otherwise, if it's 1/48th and 1/4 after year one, that's a five year total term.) Just because they vest doesn't mean you have to exercise them. For purposes of talking about the holding period below, though, I've assumed you will immediately exercise (although you don't have to and may not want to).

Grant Date: December 2011
Vesting Commencement Date: October 2011
October 2012: 5,000 vest and become exercisable
November 2012: 416.67 vest and become exercisable (assuming there's probably a provision in there rounding it up to a whole share, with the very last month making up for the difference, so 417 each month until the last month)
December 2012: 417 vest and become exercisable
etc.

Holding Period: To get capital gains treatment, the stock acquired by exercising the option must be held until the later of: (i) One year following the day the stock was transferred to you on exercise; and (ii) Two years after the date the option was granted to you.

Later of: (i) If you exercise immediately after vesting, for the 5,000 this would be October 2012; or (ii) January 2014 (depending on the exact date in December they were granted. I'm being cautious here).  This means for the first tranche to get the best tax treatment, you may not sell the underlying stock (once exercised) before January 2014. If you wait, all of the gain will be capital gain. If you sell before the holding period, the spread will be ordinary income (the different between the FMV at the date of grant and the price at exercise) and any subsequent appreciation will be capital gain.

You have to do this calculation for each tranche as it vests and you exercise.

Does this make sense?

The second provision you quoted is boilerplate. The Internal Revenue Code only allows up to $100,000 to be awarded as ISOs (because of the favorable tax treatment) before they force any other options to be treated as nonqualified. I think it's $100k per year, but I'd have to confirm that.  I'm assuming the Notice of Grant designated them as ISOs.

Also, take a look around the award agreement and/or the plan document and see if it accelerates vesting on a change in control. Sometimes they do, sometimes they don't.  That being said, if vesting is accelerated on a CIC, then all of the outstanding options would vest at that time and that would affect your holding period calculations if you exercise immediately after vesting.

Nords

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Re: Any experience with stock options?
« Reply #8 on: October 05, 2012, 11:57:54 PM »
Holding Period: To get capital gains treatment, the stock acquired by exercising the option must be held until the later of: (i) One year following the day the stock was transferred to you on exercise; and (ii) Two years after the date the option was granted to you.
If you wait, all of the gain will be capital gain. If you sell before the holding period, the spread will be ordinary income (the different between the FMV at the date of grant and the price at exercise) and any subsequent appreciation will be capital gain.
Let's say that the option is granted at $50/share, the stock IPOs at $100, the options are exercised at the IPO price, and the holder decides to hang onto the shares for cap gains tax treatment (however many months that is). 

But then when the shares are ready to be sold for cap gains tax treatment, the stock drops to $25/share.

What's the tax treatment then?

gooki

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Re: Any experience with stock options?
« Reply #9 on: October 06, 2012, 01:02:34 AM »
I wont speak on tax obligations as im not a US resident, but when I exercised my share options I bought and sold the same day. In the 5 years from grant date beginning to exercise date, the shares managed a 120% increase in value.

As for the impact on our FI, this cash allowed us to pay down our mortgage 12 months faster than we had planned (interest rate was 7.5% at that time).

kkbmustang

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Re: Any experience with stock options?
« Reply #10 on: October 06, 2012, 07:44:40 AM »
Nords- They take a capital loss.

Nords

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Re: Any experience with stock options?
« Reply #11 on: October 06, 2012, 07:47:53 AM »
Nords- They take a capital loss.
I'm under the impression that an option with a strike price at $50, exercised at $100, is a capital gain-- no matter what price the shares are worth later.

kkbmustang

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Re: Any experience with stock options?
« Reply #12 on: October 06, 2012, 07:56:44 AM »
Nords-

From the IRS:

If you are granted a statutory stock option you generally do not include any amount in your gross income when you are granted or exercise the option. However, you may be subject to Alternative Minimum Tax in the year you exercise an ISO. For more information, refer to the Form 6251 Instructions. You have taxable income or deductible loss when you sell the stock you received by exercising the option. You generally treat this amount as a capital gain or loss. However, if you do not meet special holding period requirements, you will have to treat income from the sale as ordinary income. Refer to Publication 525 for specific details on the type of stock option as well as rules, for when income is reported and how income is reported for income tax purposes.

From Publication 525: Holding period requirement satisfied.   If you sell stock acquired by exercising an ISO and satisfy the holding period requirement, your gain or loss from the sale is capital gain or loss. Report the sale as explained in the Instructions for Schedule D (Form 1040). The basis of your stock is the amount you paid for the stock.

sockmunkee

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Re: Any experience with stock options?
« Reply #13 on: October 06, 2012, 09:35:00 AM »
You have to do this calculation for each tranche as it vests and you exercise.

I gotcha.  This was the part that was throwing me off.  So for the first few tranches, the grant date will determine the optimal min date to sell for tax purposes.  Eventually (assuming we exercise immediately for each), the exercise date will determine this.

I looked for any provision regarding a change in control and couldn't find a word.  Perhaps they will amend as they get closer to IPO.

Thanks again - I feel like I actually understand know what I am doing now. 

kkbmustang

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Re: Any experience with stock options?
« Reply #14 on: October 06, 2012, 11:14:00 AM »
Happy to be able to help.

desrever

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Re: Any experience with stock options?
« Reply #15 on: October 10, 2012, 11:17:05 PM »
Maybe others will disagree with me here, but exercise-and-hold to get preferential tax treatment is not necessarily an optimal strategy for ISOs on a very volatile stock. It carries a fair amount of risk if the stock declines in value.

Make sure you understand the AMT thing, it could happen to you. Under the AMT rules, if you pursue an exercise-and-hold strategy to try to get the capital gains treatment, and the shares go down in value, you can actually wind up owing more in taxes under AMT than the shares are worth. I've seen this actual situation happen to former coworkers, it's no fun. The AMT rules are based on the calendar year, so I've heard people say that exercising early in the year has some benefit. Even still, you'll be in a position where you're checking the stock price every day, fearfully. Not a recipe for happiness! Also keep in mind that exercise-and-hold requires you to put in your own cash (strike price dollars per share) at the time of exercise. You are putting this money at risk; you could have put it in a diversified ETF.

The best advice I can give from my experience with employer stock plans of all flavors, is to (a) pretend that they have no value for goal/planning/budgeting purposes and then (b) get onto a set schedule of disposal. Write out a calendar like, "I will sell 1000 shares (or exercise for 1000) options on May 20, 2015" and so forth. Maybe once or twice a quarter. You'll be somewhat constrained by trading black-out windows once the company goes public. Don't get trapped into a situation where you could be ruined financially if the shares went down before you sold, or ruined emotionally if the shares go up after you do sell. Phase it out on a set timeline, get some averaging going, and avoid trying to time the market. If you have a disciplined schedule, then you won't wind up spending hours each day hitting F5 on finance.yahoo.com, and you can spend this time doing things that actually make you happy.

PS You don't mention the expiration term on the options -- although that's a critical factor in determining what they're actually worth. If you exercise an option before its expiration, you're giving up your exclusive (and non-transferable) right to buy that stock on a future date below market value.

kkbmustang

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Re: Any experience with stock options?
« Reply #16 on: October 11, 2012, 06:43:22 PM »
I will also add that there are some very complicated stock swap rules. I know just enough to know it's an issue you should ask about, but not enough to risk not being dangerous. I won't comment on the issue other than to say to be aware of it.