Author Topic: Employer stock options  (Read 5633 times)

NewPerspective

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Employer stock options
« on: January 24, 2015, 02:29:25 PM »
Ok smart people -

Can someone help me understand the tax implications of Incentive Stock Options vs a discounted stock purchase plan offered by a company?

I have read that ISOs are treated differently under tax code but I'm having a hard time understanding how it is different.  I believe they are taxed as Capital Gains (and not regular income taxes) but aren't regular stocks taxed as capital gains (and there is a short term vs. long term)?

Thank you!


bacchi

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Re: Employer stock options
« Reply #1 on: January 24, 2015, 02:47:54 PM »
The discount is regular income for qualified ESPPs. The stock price difference at sell time is capital gains.

ISOs are always capital gains. The gains are used for AMT purposes, though, if the stock isn't sold. (Pro tip: File an 83-b for ISOs to start the clock ticking.)

MDM

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Re: Employer stock options
« Reply #2 on: January 24, 2015, 02:54:07 PM »
NewPerspective, yes there are various flavors of stock options.  Below are a few threads with discussions and links.  Might be best for you to take a look, then summarize your understanding of what happens when you
-  are granted an ISO
-  are granted an NQSO
-  exercise an ISO
-  exercise an NQSO
-  sell the stock you received from the ISO immediately after purchasing
-  sell the stock you received from the ISO > 1 year after purchasing
-  sell the stock you received from the NQSO immediately after purchasing
-  sell the stock you received from the NQSO > 1 year after purchasing

Then folks can applaud or correct your understanding.

And there are also Restricted Stock Options - but that's for later if needed.

http://forum.mrmoneymustache.com/investor-alley/in-the-money-options-what-to-do/
http://forum.mrmoneymustache.com/investor-alley/your-2014-1099-b-form-for-an-espp-sale-will-probably-be-wrong/
http://forum.mrmoneymustache.com/ask-a-mustachian/large-lot-of-nso's-need-tax-help!/
http://forum.mrmoneymustache.com/investor-alley/when-to-exercise-stock-options/
http://forum.mrmoneymustache.com/ask-a-mustachian/stock-options-in-the-company-a-good-or-bad-idea/

NewPerspective

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Re: Employer stock options
« Reply #3 on: January 25, 2015, 08:37:41 AM »
Thanks for all the links MDM. My husband and I have been going through and really trying to understand all of the tax implications.  It is complicated!

We do have a CPA that does our taxes for us (we tried to do it last year ourself and went horribly wrong).  I'm assuming he has been filing everything correctly, however he hasn't done a great job of educating us (although, maybe that isn't really his job).

I now understand my husband has or will potentially have three kinds of stocks:

Non qualified stock purchase plan
Incentive Stock Options
RSU

For the stock purchase plan, we have been making sure we have a qualified position, i.e. we have been holding for a least two years from the beginning of the purchase window and a year since the exercise date.

We were really confused by the compensation element.  His employer does NOT automatically include this on the W2.  So I am assuming our CPA has done this (we will be checking with him this week). 

Please correct me if I have any faulty understanding.

Thank you again for the information.  This has been really enlightening. 

NewPerspective

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Re: Employer stock options
« Reply #4 on: January 25, 2015, 10:05:47 AM »
Just wanted to add one more comment to see if my thinking is logical.

I had posted another thread wondering about investing vs. paying off our house.  (knowing that actual dollars earned on the investments, should outperform our 3.5% mortgage.  However, paying off our house is a key to being FI).  We would like to achieve FI within the next five years (sooner if possible).  So with those thoughts in mind, I think it makes sense for us to sell company stock as soon as we have met the requirements for a qualified position, then go ahead and put it toward our house. 

My thinking here is if we reinvest this money (instead of paying the house now) we face the issue of selling it at some point to pay off our house anyway (if we want to pay it off early, which I think we do).  We will likely still be in a high income tax bracket, so we will pay capital gains tax.  At some point in the future, we will be in the 15% federal tax bracket so it would make sense to hold off on selling investments until then.   We will want our house paid off before we are in that lower income bracket.

Thoughts?

MDM

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Re: Employer stock options
« Reply #5 on: January 25, 2015, 11:16:14 AM »
I had posted another thread wondering about investing vs. paying off our house.  (knowing that actual dollars earned on the investments, should outperform our 3.5% mortgage.  However, paying off our house is a key to being FI).  We would like to achieve FI within the next five years (sooner if possible).  So with those thoughts in mind, I think it makes sense for us to sell company stock as soon as we have met the requirements for a qualified position, then go ahead and put it toward our house. 

My thinking here is if we reinvest this money (instead of paying the house now) we face the issue of selling it at some point to pay off our house anyway (if we want to pay it off early, which I think we do).  We will likely still be in a high income tax bracket, so we will pay capital gains tax.  At some point in the future, we will be in the 15% federal tax bracket so it would make sense to hold off on selling investments until then.   We will want our house paid off before we are in that lower income bracket.
Financially, it will always be better to invest in whatever provides the highest returns.  There are a variety of conditions (e.g., mortgage interest deductible or not), but a few minutes with a spreadsheet could tell you some things about your specific situation.  Let's say you have $100K due on the mortgage and have $100K in cash.   You could
-  Pay off the mortgage.  Done.  You have a paid house and $0 in cash.
-  Invest the $100K for a return higher than the mortgage interest rate.  You use the principal and investment returns to pay off the mortgage over time.  Because you investment grows faster than the mortgage payments deplete it, you end up with a paid house and some amount invested.  If you sell your investment, you will pay some tax but the tax is only a fraction of the investment return so you have a paid house and some amount (>$0) in cash.

Of course if the investment returns are lower than the mortgage interest rate it is better to pay off the mortgage.  The correct strategy is knowable only in hindsight.


MDM

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Re: Employer stock options
« Reply #6 on: January 25, 2015, 11:26:17 AM »
...
I now understand my husband has or will potentially have three kinds of stocks:

Non qualified stock purchase plan
Incentive Stock Options
RSU
...
We were really confused by the compensation element.  His employer does NOT automatically include this on the W2.  So I am assuming our CPA has done this (we will be checking with him this week). 
...
He might have more than one type, but it is most likely that he has only one of ISO, NQSO, or RSU.  The employer, being the one who administers the program, will know for sure.  Your husband should ask (or look at the paperwork given to him when the options were granted and exercised).  The CPA had to know (or assume...) in order to handle things properly.  You could ask the CPA how he knew.

We could go into great detail about the differences among the various options, but for practical purposes it would be best to know the specific type you have, deal with that, and ignore the others.



NewPerspective

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Re: Employer stock options
« Reply #7 on: January 25, 2015, 12:01:17 PM »
...
I now understand my husband has or will potentially have three kinds of stocks:

Non qualified stock purchase plan
Incentive Stock Options
RSU
...
We were really confused by the compensation element.  His employer does NOT automatically include this on the W2.  So I am assuming our CPA has done this (we will be checking with him this week). 
...
He might have more than one type, but it is most likely that he has only one of ISO, NQSO, or RSU.  The employer, being the one who administers the program, will know for sure.  Your husband should ask (or look at the paperwork given to him when the options were granted and exercised).  The CPA had to know (or assume...) in order to handle things properly.  You could ask the CPA how he knew.

We could go into great detail about the differences among the various options, but for practical purposes it would be best to know the specific type you have, deal with that, and ignore the others.




MDM, thanks very much for taking the time to read and respond to me.  I really appreciate it.

So, I am fairly certain he has three types.  The ESPP - which is taken from his paycheck and exercised every six months and everyone can participate if they choose to.

He has also been given as a reward ISO's (as a good job/special occasion thing) and he will receive RSUs (as a REALLY good job, maybe a one time only thing).

So I do think we are dealing with three different tax scenarios, although at this moment we are only contemplating what to do with the ESPP.

Does it seem odd to have the three different types?
« Last Edit: January 25, 2015, 12:13:56 PM by NewPerspective »

MDM

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Re: Employer stock options
« Reply #8 on: January 25, 2015, 12:25:18 PM »
So, I am fairly certain he has three types.  The ESPP - which is taken from his paycheck and exercised every six months and everyone can participate if they choose to.

He has also been given as a reward ISO's (as a good job/special occasion thing) and he will receive RSUs (as a REALLY good job, maybe a one time only thing).

So I do think we are dealing with three different tax scenarios, although at this moment we are only contemplating what to do with the ESPP.
That's great for both of you!

I'm more than a little surprised that the ESPP benefit has not been included in a W-2.  The http://forum.mrmoneymustache.com/investor-alley/your-2014-1099-b-form-for-an-espp-sale-will-probably-be-wrong/ thread describes some different ways ESPPs are administered, but in any of those ways there is an "ordinary income" component.  Definitely worth a question to the company payroll and/or HR department.

The company for which I worked switched from ISOs to NQSOs a while back so my ISO knowledge is dated.  Comments that ISO exercise can trigger an Alternative Minimum Tax liability are, I believe, still true.  Good topic for discussion with CPA and some of your own targeted internet research. 

RSUs can be done in many ways.  Best to ask HR directly about how this particular company does it.

Nice problems to have - keep up the good work. :)

AJDZee

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Re: Employer stock options
« Reply #9 on: January 25, 2015, 08:10:17 PM »
I'm sure the tax code is Canada is similar to the U.S., but the difference is...


ESPP: the discount your employer gives is on the shares is taxable as if it were extra income.
         then if it's not in a tax-sheltered account, you pay regular capital gains tax when you sell

Options: you will pay capital gains tax on the difference between sale price and strike price. (This is your most tax friendly option, but if stock price goes below the strike price your options are worth $0)

RSUs: are taxed as income, but even if stock goes down they'll always be worth what the share price is.

In the past Ive had the choice to direct a certain % of a bonus between options and RSUs. If you choose RSUs, a certain 'divider' was applied, I.e '5', so you could get 1,000 options or 200 RSUs.
At the time I was optimistic about my company, and therefore options seemed like the best choice. I was very very wrong, and watched the price drop below strike and stayed there for years. (The price almost doubled about a month after I left the company)

seattlecyclone

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Re: Employer stock options
« Reply #10 on: January 26, 2015, 08:33:33 AM »
The regular income portion of ESPP shares doesn't "count" until you sell the shares. If you still own the shares, it's correct that the income never showed up on your husband's W-2. If you already sold some of them and the income still didn't show up, it's possible the brokerage didn't tell the employer about it and you were instead supposed to do it yourself.

MDM

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Re: Employer stock options
« Reply #11 on: January 26, 2015, 09:05:31 AM »
The regular income portion of ESPP shares doesn't "count" until you sell the shares. If you still own the shares, it's correct that the income never showed up on your husband's W-2. If you already sold some of them and the income still didn't show up, it's possible the brokerage didn't tell the employer about it and you were instead supposed to do it yourself.
This may be true for some ESPPs.  It is not true for all - in particular, the one in which I participated. 

I'm surprised that it is true for any ESPP that allows the employee to sell shares immediately after purchase, because the the employee is in constructive receipt of the difference between market and strike price when the company contributes that money to allow the employee to purchase the shares.  At least, those were the terms of my ESPP and that difference always appeared on the W-2.

NewPerspective

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Re: Employer stock options
« Reply #12 on: January 26, 2015, 09:54:50 AM »
The regular income portion of ESPP shares doesn't "count" until you sell the shares. If you still own the shares, it's correct that the income never showed up on your husband's W-2. If you already sold some of them and the income still didn't show up, it's possible the brokerage didn't tell the employer about it and you were instead supposed to do it yourself.

I am under the impression we are supposed to report it ourselves the year it is granted. But I could be wrong - this gets incredibly murky for me.

The regular income portion of ESPP shares doesn't "count" until you sell the shares. If you still own the shares, it's correct that the income never showed up on your husband's W-2. If you already sold some of them and the income still didn't show up, it's possible the brokerage didn't tell the employer about it and you were instead supposed to do it yourself.
This may be true for some ESPPs.  It is not true for all - in particular, the one in which I participated. 

I'm surprised that it is true for any ESPP that allows the employee to sell shares immediately after purchase, because the the employee is in constructive receipt of the difference between market and strike price when the company contributes that money to allow the employee to purchase the shares.  At least, those were the terms of my ESPP and that difference always appeared on the W-2.

I'm surprised too.  This is a large global company, I would have thought they would report it on the W-2.  My husband logged into his company benefits website over the weekend and it definitely said in black and white that they do not report it.

seattlecyclone

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Re: Employer stock options
« Reply #13 on: January 26, 2015, 10:38:36 AM »
The reporting requirements could vary by employer. What doesn't vary is you don't have any income from ESPP shares until you sell the shares -- the breakdown between earned income and capital gains depends on whether you held on to the stock for the full holding period or not. See this post for more detail.

My opinion is that the tax benefit to be realized by keeping your ESPP shares for the full holding period is generally not worth the risk inherent in holding too much of your employer's stock. You're going to have some earned income either way, holding for an extra 12-18 months doesn't change it very much unless the stock increased in value by a significant amount during the offering period.

MDM

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Re: Employer stock options
« Reply #14 on: January 26, 2015, 11:41:17 AM »
As usual, it's all in the assumptions.  I'm guessing seattlecyclone has been referring to "Section 423" ESPPs.  For whatever reason, apparently my experience was with a "Non-Section 423 ESPP."  Appears that saying "ESPP" is not specific enough....

From http://corporate.findlaw.com/corporate-governance/designing-and-implementing-a-section-423-espp.html:
Quote
Federal Income Tax Considerations . Section 423 Plan
If a plan meets all the requirements discussed above, an employee who purchases stock under the ESPP will not recognize income for federal income tax purposes on the purchase, but will instead defer the tax consequences until the employee sells or otherwise disposes of the stock.

Federal Tax Consequences . Non-Section 423 ESPP
In some cases, an ESPP may not qualify under Section 423, either by design or as a result of plan operation. In such cases, stock purchased under the plan will be treated, for tax purposes, as though it had been acquired under a nonstatutory stock option. As a result, a plan participant will not recognize income by virtue of participating in the plan, but will recognize ordinary compensation income for federal income tax purposes at the time of purchase measured by the excess, if any, in the value of the shares at the time of purchase over the purchase price. If the participant is also an employee of the company, the compensation income recognized at the time of purchase will be treated as wages and will be subject to tax withholding by the company.