Equity Compensation Advisor

Taxation of Incentive Stock Options – ISO’s
In this, my fifth and final submission to the blog series on the taxation of different equity awards, we examine the “Taxation of Incentive Stock Options” or ISO’s, the benefits and tax implications.

Tax Benefits:  Holders of ISO’s are eligible for certain potential tax benefits that are not available in the previously discussed equity awards.  The main tax benefit of ISO’s is the ability to convert compensation income into long-term capital gain.   In order to qualify for the long- term capital gain rate, the option holder must hold the stock for a specified period of time after exercise.

There are four tax benefits of ISO’s over other equity awards:

1.  At the time of exercise, the option holder does not report any income for regular tax purposes.
2.  If the option holder holds the shares long enough to avoid a “disqualifying disposition” (for future blog discussion) the bargain element (gain) will be taxed as long-term capital gain.
3. The bargain element from the exercise or profit from the sale is not subject to income tax withholding or Social Security tax.
4. If the shares are sold in a disqualifying disposition, they may still be able to limit the amount of income reported to the actual profit from the purchase and sale, versus a non qualified option that must report the actual gain at the time of exercise.  This applies regardless if the shares drop in value after the exercise.

So exactly what are the potential tax implications when ISO’s are exercised?  In most cases an option holder who exercises an ISO, and holds the shares beyond the end of the year of exercise, will be subject to AMT tax.

Dan’s Moral: ISO’s give the option holder the ability to convert the gain into long-term capital gains if the proper strategy is used.

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For more information on Dan Langworthy and Executive Capital, LLC you can also visit our website: http://www.executivecapitalmn.com and view Dan’s profile on Linkedin http://www.linkedin.com/in/danlangworthy

Securities and advisory services offered through LPL Financial, a Registered Investment Advisory, Member FINRA/SIPC

Nonqualified Stock Options
As the series continues, Part 4:  Non-qualified Stock Options are explored as we compare similarities, differences, tax implications, and timing for exercising options.  See example below:

As mentioned in my previous blog, Non-qualified Stock Options (NQO’s) are similar to Stock Appreciation Rights (SAR’s).                                         

What are the differences?   The main difference is that SAR’s provide the holder with the right to receive cash and NQO’s provides the holder the opportunity to by a fixed number of shares at a price determined when the options were granted.

• In summary:   A NQO holder does not report income until they exercise the option.  At the time of exercise, the option holder must pay the exercise price (grant price) and is taxed (compensation income) on the difference between the exercise price and the current price.

Example:

• If the option holder exercised all the options they would report compensation income of $40,000 ($45-$25 X 2,000).
• If the holder is an employee of the company, the income from exercising the option will be subject to withholding and social security tax.

Dan’s Moral:  Because there is no cost or tax implication to the holder at the time the option is granted, options allow the holder to participate in the appreciation of the stock with no cost.

• Please be sure to subscribe to our blog to be automatically notified as the series continues on the “Tax Implications of the Five Types of Equity Compensation, Part 5″. 

For more information on Dan Langworthy and Executive Capital, LLC you can also visit our website: http://www.executivecapitalmn.com and join Dan’s network on Linkedin http://www.linkedin.com/in/danlangworthy

Securities and advisory services offered through LPL Financial, a Registered Investment Advisory, Member FINRA/SIPC

In this five part series we have covered the tax implications of Restricted Stock Grants and Restricted Stock Units.  In part three, we will be discussing the tax implications of Stock Appreciation Rights (SAR).

What are Stock Appreciation Rights:

Stock Appreciation Rights (SAR’s) provide the executive with the right to receive cash in the amount of increase in value of a specified number of shares. The following are some common questions and answers about SAR’s that should help define and differentiate them.

How are SAR’s similar to options:

SAR’s are similar to options in that the executive determines when to exercise the shares.

How do SAR’s differ from options:

Unlike an option, the SAR does not require the executive to come up with the cash at the time of exercise.  By simply exercising the SAR, the executive receives cash.

Note:  However, sometimes companies may grant SAR’s that pay off in shares of the company stock.  By paying off in stock, the company does not need to come up with the cash.

This brings us to the main objective — Taxes:

• SAR’s are taxed the same as non qualified stock options.
• When the executive is granted the SAR or when it becomes exercisable, there are no tax implications.
• At the time of exercise, the executive reports ordinary income on the amount of cash received.
• If the executive receives shares, they will report income equal to the value of the shares the day they are transferred.

Dan’s Moral:  SAR’s provide the executive a way to participate in the appreciation of their company stock without having to come up with money out of their own pocket at the time the SAR is granted, as well as when they are exercised.

• Please be sure to subscribe to our blog to be automatically notified as the series continues on the “Tax Implications of the Five Types of Equity Compensation, Part 4″. 

For more information on Dan Langworthy and Executive Capital, LLC you can also visit our website: http://www.executivecapitalmn.com and join Dan’s network on Linkedin http://www.linkedin.com/in/danlangworthy

Securities and advisory services offered through LPL Financial, a Registered Investment Advisory, Member FINRA/SIPC

Restricted Stock Units; Part 2 of my five-part blog series on the tax implications of the five types of equity compensation:    Restricted Stock Grants, Restricted Stock Units, Stock Appreciation Rights, Non-qualified Stock Option, Incentive Stock Options

 Throughout this series, we will discuss the tax implications of each of the five types of equity compensation first as described in my previous blog published 11/29/2011 (“Five Types of Equity Awards”). 

In my previous blog, Part One of the series, we discussed Restricted Stock Grants, and the tax implications involved.  Part Two consists of defining the second type of equity compensation; Restricted Stock Units (RSU’s), and important components including forfeiture, tax consequences, timing and more.

• Restricted Stock Units (RSU’s) are very similar to Restricted Stock Grants with one exception, the time when the shares are transferred.  Restricted Stock Grants are transferred at the time of the grant even though the executive may not have direct access to the shares due to possible forfeiture based on the vesting schedule.
• In the case of RSU’s the company does not transfer shares at the time of the grant.  The shares are transferred once the employee has worked long enough to meet the required time period.  Fundamentally, the employee would not be entitled to any dividends until the shares are transferred.  Also, due to the fact that the shares are not transferred at the time of grant, the executive cannot file a section 83b election to convert future appreciation of the shares to capital gain. 

Keeping in mind that since the executive does not have access to the shares when granted, there are no tax consequences until the shares are transferred.    At the time of transfer, the shares become vested and the executive will report compensation income on the entire value of the shares.  This amount is the cost basis for tax purposes.

Dan’s Moral:  Because the company determines the timing and restrictions placed on RSU’s, the only decision the executive needs to make is whether to hold the shares at the time of transfer or sell them.

• Please be sure to subscribe to our blog to be automatically notified as the series continues on the “Tax Implications of the Five Types of Equity Compensation, Part 3″. 

For more information on Dan Langworthy and Executive Capital, LLC you can also visit our website: http://www.executivecapitalmn.com and join Dan’s network on Linkedin http://www.linkedin.com/in/danlangworthy

Securities and advisory services offered through LPL Financial, a Registered Investment Advisory, Member FINRA/SIPC

This is the first entry in a five-part blog series on the tax implications of the five types of equity compensation.  Throughout the the series, we will discuss the tax implications of each of the five types of equity compensation, as described in my previous blog published 11/29/2011 (“Five Types of Equity Awards”).

Part One:
We will begin part one by focusing on Restricted Stock Grants.  A restricted stock grant is stock that a company issues to an employee and is restricted (not vested) until the employee can terminate their employment without forfeiting their shares (vesting date).

The tax treatment for restricted stock can be complicated based on the type of restriction the company has placed on the shares and whether the executive elects to file the 83b election when the shares are transferred to them (future blog).  In this blog we are going to assume “substantial risk of forfeiture” (described later) on the shares and the executive does not file the 83b election.

The tax implications for restricted stock mentioned above does not exist until the shares become vested.  In other words there is no income to report until the year in which the shares vest.  Once the stock is vested, the executive would report compensation income based on the value of the stock on the vesting date.

Usually, once the shares are transferred by the company to the executive, they become vested and are then taxable.  Stock is considered vested when either of the following actions occurs:

• The shares are transferable.  This occurs when the executive can transfer the shares to any other person, but only if that person accepts the shares and are not subject to “substantial risk of failure.”

“The stock is not subject to “substantial risk of failure.”

• This means that the executive will lose some or all of the value of the shares unless they continue working for the company for a specified period of time.

Dan’s Moral:  As you can see, simply receiving restricted stock from your employer can be more complicated than it might appear, based on the restrictions placed on the shares and the vesting schedule.

Please be sure to subscribe to our blog to be automatically notified as the series continues on the “Tax Implications of the Five Types of Equity Compensation”.

Securities and advisory services offered through LPL Financial, a Registered Investment Advisory, Member FINRA/SIPC