SMITH & ASSOCIATES
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COMMUNICATIONS
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Sitemap
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SMITH & ASSOCIATES: Stock Options
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Some things to know about Stock Options
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STOCK OPTIONS???????
As the world turns the search and recruiting world turns with it. I am sure you will agree that the speed at which our business is traveling is mind boggling. Therefore it is very important that we arm ourselves with the right information so as to advise our clients and candidates as to how best to navigate their way through these accelerated times.
One area that comes to mind is the various ways candidates are lured to new employment with promises of riches. Stock options are widely used bait by just about all of the start up companies. Additionally many of the established companies are using stock options as a lure for new hires too.
As a result of the rapid pace of today’s business world we have seen these promises of stock option riches come to past for better and more often for worse. After reading several articles and writings on this subject I thought it would be important to share some of my findings with you. The dot come shakeout is claiming new wave of victims: workers who face huge tax bills on phantom profits from employee stock options.
Employees who used incentive options to buy company stock earlier this year and then held onto their shares have often seen their paper gains evaporate as high-tech issues tumbled. But thanks to the way the options are taxed, these workers often must pay tax based on their original paper profit, whether or not they saw the money.
In some cases the tax bill is so big, and the stock now worth so little, that families are scrambling for ways to meet their obligations to Uncle Sam, tax preparers say. There is one possible avenue of escape, but the workers have to act before the end of the year.
One example I read in the LA Times illustrates what happen to a local dot-com executive. He used incentive stock options to buy more than 240,000 shares of his company’s stock at 14 cent a share Jan. 12. The stock closed at $19.75 that day, meaning he paid about $33,700 for $4.7 million worth of stock.
Today, however, the stock is trading for around 19 cent and the shares are now worth $45,600. But he faces a tax bill of more than $1 million, based on the value of the shares the day he bought them.
The problem isn’t limited to executives. As more companies grant options to rank-and-file workers, accountants say they are increasingly counseling middle-income employees who face large and often unexpected tax bills. Many of these employees are earning around $30,000 to $40,000 per year and are experiencing huge tax bills, thanks to options, according to Robert Munger, a Silicon Valley CPA who specializes in stock options issues.
The loss of stock wealth has been dispiriting for those who accepted options in lieu of higher salaries in hopes of reaping huge gains when the stock price soared. Those dreams, especially prevalent at tech companies, evaporated as the NASDAQ composite index plunged more than 50% from its March all-time high. But the tax reality comes as a particular shock to those who thought incentive stock options couldn’t be taxed when used to but shares. This misunderstanding is widespread, tax prepares said.
Knowing something about stock options will help each of us better serve and advise our clients and candidates about salary packages. This information help us advise a candidate about a job that looked good on paper was exciting as it was in new technology, and it was laced with stock options. After some council and careful review of the long-term issues, the candidate decided to choose the more conventional career opportunity that offered a strong salary package with a stock purchase plan that did not have the tax ramifications that non-qualified stock options carry.
There are two basic types of options: non-qualified stock options, typically issued to workers, and incentive stock options, which are usually offered to executives. Non-qualified options are taxed sooner and at higher rates than incentive options, but incentive options can trigger the dreaded alternative minimum tax.
With non-qualified options, you owe regular income tax on the difference between the price you paid for the stock and its fair market value as soon as you purchase the shares, even if you don’t sell the stock right away. With incentive options, no regular tax is due when you purchase the shares and the gain can be taxed at favorable capital gains rates if you hold the shares at least a year after purchase (and two years from the day the options were granted).
However, you may owe alternative minimum tax in the year you purchase your shares, particularly if you scored a large paper profit. The AMT is a parallel tax system that has two tax rates, 26% and 28%, and allows far fewer deductions than the regular income tax system.
For more specific details on tax treatment of options, see a good CPA.
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