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Stock Based Compensation

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Stock Based Compensation

 

Stock options let your employer reward you today with tomorrow’s stock gain. Options give you the right, but not the obligation, to buy or sell stock at a specified strike price by a specified expiration date. To exercise the option, you pay the strike price then take delivery of the shares. Your gain is the difference between the option price and the fair market value (“FMV”), or “spread.” There are two main forms of options:

  • Incentive stock options (“ISOs”) let you defer tax until you actually sell your shares. At that point, you’ll owe tax on the spread at long-term capital gain rates if you hold the shares at least two years from the grant date or one year from the option date (whichever is greater). Any further gain when you sell is taxed as capital gain, depending on how long you hold the shares after you exercise the option. But, the difference between the option price and the stock’s FMV at exercise is subject to AMT. If the stock price falls after you exercise your options, you can even owe AMT on your losses. (To avoid this, you can sell your shares and pay tax at ordinary rates on any remaining gains. Consider exercising early in the year so you can wait and see what happens.)
  • Nonqualified stock options (“NQSOs”) are more flexible because there’s no holding period to meet before you sell. No tax is due when the employer grants the option. You pay tax, at ordinary income rates, on the spread when you exercise the option. Any further gain or loss is taxed as capital gains, depending on how long you hold the stock after exercise.

Restricted stock grants let your employer pay you in actual stock - with strings attached. Grants aren’t taxed until the stock “substantially vests” (you can actually sell it or there’s no longer “substantial risk of forfeiture”). The stock’s FMV at vesting (minus any purchase price you pay) is treated as compensation (taxed as ordinary income and subject to payroll taxes). Any further gain or loss is taxed as capital gain according to how long you hold it after vesting. However, Code Section 83(b) lets you treat the stock as vested, for tax purposes only, when awarded. The stock’s FMV at that time is taxed as compensation. Any further gain or loss is treated as capital gain according to how long you hold it after electing §83(b) treatment. This election effectively takes any gain from the date of the award to the date of vesting and converts it from ordinary income to capital gain. But — if that stock ultimately never vests, you’ll have paid tax on gains that never materialized.

 

 

 

 

 

 

 

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