With the holidays in full force, it seems kind of awful to think about taxes for your employee stock options, right? Perhaps so. But there could be some nice savings for 2016. Besides, employee stock options have a big-time tax component and are often a major chunk of a person’s wealth.
OK then, what are some of the things to consider? Well, let’s take a look:
Get Organized: You need to make sure you have everything in order. So to this end, put together a spreadsheet or notebook that sets forth all your equity, whether incentive stock options, nonqualified stock options, restricted stock units (RSUs), employee stock purchase plans (ESPPs) and so on. Mark the exercise prices, the dates of the grants and the vesting periods.
No doubt, this process will be a huge help when it comes to planning.
Know the Tax Breakpoints: The federal tax brackets range from 10% to 39.6%. There are also potential state and local taxes as well as FICA taxes (for Social Security and Medicare).
Now given that the exercise of an employee stock option can result in substantial income, the tax impact can definitely be painful. Thus, to gauge it, you can use online tax software, such as TurboTax, and then run scenarios.
Although, this does not necessarily mean you must avoid it at any cost. The fact is that you could wind up paying less taxes with AMT because ISOs allow the potential to benefit from lower capital gains rates. But the hitch is that you cannot sell the shares within a year of the exercise.
This is why the January strategy is interesting. That is, when you exercise an incentive stock option early in the year, you will have a pretty good idea by the end of December if it makes sense to pay the AMT or sell the stock and avoid the tax.
Life Changes: What if you plan to get another job next year or perhaps start a business? If so, you may have lower income. As a result, it may make sense to defer your option exercises to next year, which may mean paying a reduced tax.
But it is also critical that you understand the terms of the option agreement. Keep in mind that there are often strict requirements and deadlines when you leave a company.
Taxes Are Not Everything: While taxes are important, they should not be the sole factor when dealing with employee stock options. Rather, it is also critical to focus on key financial matters like diversification. As seen lately with tech IPOs – such as with Apigee (APIC), Pure Storage (PSTG) and Box (BOX), just to name a few – the valuations can be volatile.
So even if you are upbeat on the prospects of your company, it makes sense to still take gains over time. After all, as legendary investor John Templeton once said: “The only investors who shouldn’t diversify are those who are right 100% of the time.”