Many companies, especially tech start-ups, offer stock options to their employees as a part of their benefits package. A stock option allows employees to buy shares of the company at a price and time designated by the employer, without obligating them to do so. When the companies stock rises, shareholders can greatly benefit. Stock options have the potential to yield a significant amount of money, but only if you utilize them correctly and the company does well on the market.
What are Stock Options?
Stock options are just that – an option for employees to buy stock in the company. They are often set at a discounted price, which is typically the market price of the stock when the option is given to the employee. The right to exercise the options happens after a certain period of time, so the hope is that the price of the shares will increase. This will yield a profit so as long as a company does well, allowing employees to make a profit by having stock options.
There are two types of stock options: non-qualified stock options (NSO) and incentive stock options (ISO). NSO and ISO differ in two main ways. NSOs are typically offered to consultants, outside directors, and non-executive employees while ISOs are strictly for executives. NSOs do not have any special federal tax treatment, while ISOs do.
Your stock options might also come with a vesting period, which means that your ability to buy the stock is spread out over a period of time.
1. Exercise the Options
The first thing to do, naturally, is to exercise the stock options you have. This basically turns the options into actual stock. When you exercise the stock option can be important to ensuring you get the most out of the options. Your stock options will come with certain rules and regulations, including a period of time where you can exercise them. Once you enter this period of time, you want to look at the market to ensure you get the best value for your stock options when you do exercise them. Once you have exercised the option, you have some decisions to make on how to proceed.
2. Turnaround Sell
You can choose to enact a quick turnaround sell on your stock options. This basically means that once you have converted your options to stock, you buy them and then sell them after you wait the period of time contracted in your options’ contract.
3. Wait it Out
You can take the stock and keep it in your investment portfolio, waiting to sell it at its ideal moment. This has the potential to bring in even more profit, or you might end up with a loss instead of a profit.
4. Half and Half
One of the safest ways to proceed is to do both. You can take a percentage of your stock options and sell them right away for a profit, and then keep the rest with your investment portfolio with the hope it will grow over time. You can break it up however you want, whether an even split of fifty-fifty or some other percentage.
How do I exercise my right to use my stock options without paying a lot in taxes?
When you sell your stock will deterring how many taxes that you pay. If you exercise and sell your stock in the same fiscal year, you pay your regular income tax rates. However, if you hold onto the stock for longer, you will pay long-term capital gain rates, rather than ordinary income tax rates.
NSOs are taxed at the start of exercise, and because they are considered compensation, they are taxed at the normal income tax rate. ISOs have special tax guidelines. There is no taxable event when the options are exercised, although it might trigger an alternative minimum tax. When the shares are sold, it becomes a taxable event.
To save money on taxes, you should hold onto the stock so that you have a lower tax rate. Additionally, if you sale the stock at different times, rather than all at once, you will save money on your taxes.