These types of compensation can be very lucrative for the employees but also have many rules and may be taxed differently depending on holding periods and types of awards. It is extremely important that you discuss with your advisor and tax professional before deciding on what to do with your awards.
What Is A Stock Option?
Stock options give you a potential share in the growth of your company's value without any financial risk to you until you exercise the options and buy shares of the company's stock. Moreover, while cash bonuses and most other forms of compensation are taxable when you receive them, stock options defer taxes until you exercise them. Before you exercise your options, their built-in value is subject to pre-tax growth—which can be significant.
Stock options give you the right to purchase a specified number of shares of the company's stock at a fixed price during a rigidly defined timeframe. The purchase is called the exercise, and the fixed price set at grant is called the exercise price. Typically, you must continue to work at the company for a specified length of time before you are allowed to exercise any of the stock options. That length of time is called the vesting period, which is characterized by a vesting schedule.
How Do Stock Options Work?
Since the exercise is nearly always the company's stock price on the grant date, stock options become valuable only if the stock price rises. However, any value in the stock options is entirely theoretical until you exercise them—i.e. until you pay money to buy the shares at the exercise price. After you have acquired the shares through this purchase, you own them outright, just as you would own shares bought on the open market.
Two Types of Stock Options
Companies can grant two kinds of stock options:
Restricted stock and its nearly identical twin restricted stock units (RSUs) are ways of granting company shares to employees. The grant is "restricted" because it is subject to a vesting schedule, which can be based on length of employment or on performance goals, and is governed by other limits on transfers or sales that your company can impose. Unlike stock options, restricted stock and RSUs always have some value to you, even when the stock price drops below the price on the grant date.
Unlike stock options, which can go "underwater" and lose all practical value with a falling stock price, restricted stock and RSUs are always worth something, even if the stock price drops dramatically. In other words, unlike with options it does not matter what the stock price was on the grant date of restricted stock or RSUs. However, because these grants have full value at vesting, companies grant fewer shares or units of restricted stock than stock options.
Usually, however, you cannot sell or otherwise transfer the shares until you have satisfied vesting requirements. As long as you continue to work at your company, you will not forfeit your grant, and it will not expire. The principal traits of restricted stock include the following:
Taxation of Restricted Stock
With restricted stock, you pay tax at the time the restrictions on the shares lapse. This typically occurs when you have satisfied the vesting requirements and are certain to receive the stock (i.e. there is no longer any risk of forfeiture). With RSUs, you are taxed when the shares are delivered to you, which is almost always at vesting.
Your taxable income is the market value of the shares at vesting. You have compensation income subject to federal and employment tax (Social Security and Medicare) and any state and local tax. That income is subject to mandatory supplemental wage withholding. hen you later sell the shares, you will pay capital gains tax on any appreciation over the market price of the shares on the vesting date.
There are many strategies that should be evaluated when deciding on what to do with your restricted stock and options and there are many factors to be considered, including your total net worth, future awards, expectations about stock price and your overall risk tolerance. It is equally as important to work with your advisor and CPA to ensure you’re minimizing your tax hit while prudently diversifying your newly acquired wealth.
Of course your GK advisor is quite versed in these strategies and will be happy to help you evaluate your options.
By Hatem Dhiab
Gerber Kawasaki Managing Partner
*Some information was referenced and sourced from www.mystockoptions.com
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which course of action may be appropriate for you, consult your financial advisor. No strategy assures success or protects against loss.
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