Stock options are often used as an incentive for key employees and executives. For example, Apple CEO Tim Cook received a $3 million salary in 2021, which may seem relatively small given the enormous value of the company. But the full scope of his compensation package becomes clearer when you also consider he was awarded $82.3 million in stock options [1].
Stock options aren’t just for household names. Companies of many sizes use incentive stock option (ISO) plans to attract and retain top talent. But these same stock options can also end up costing significant amounts of money in taxes when they aren’t exercised strategically. In this post, we’d like to explore some tips for reducing the tax bill associated with stock options.
5 Strategies to Help Minimize the Taxation of Stock Options
If you receive stock options as part of your employer’s compensation package, you need a plan to keep taxes as manageable as possible.
1. Exercise Your Options Periodically
It can be tempting to hang on to your stock options until they expire (generally 10 years) so that you get a chance to maximize the profit between the exercise price and the purchase price. However, remember that this strategy will also trigger ordinary income taxes. Unless you’re prepared for this bill, you could inadvertently put yourself in a situation that’s financially challenging.
One way to avoid the buildup of a single large instance of exercising options is to exercise a small portion of your options every year. We recommend working with a financial professional to develop a ladder-style approach, which could potentially prevent the tax bill from getting too high at once.
2. Don’t Hold Too Much Wealth in Stock Options
Another good reason not to wait until the last minute to exercise your stock options is that no one has the crystal ball. We do not know what the future may hold. If the market were to crash (or if the company were to go bankrupt), then those options may not be as valuable as they once were.
Generally speaking, an investor should be cautious to hold a concentration of their net worth in any one stock (including options for that stock). This is yet another argument in favor of exercising a portion of your options each year in a tax-efficient manner.
3. Don’t Pay Taxes Twice on the Same Options
You may not realize it, but any stock options you exercised may be double reported and could potentially lead to inaccurately paying more than is needed.
Due to a rule that took place in 2014, all brokers must report the cost basis for stock that was both acquired and sold on Form 1099-B. Unfortunately, due to the way brokerages must prepare this form, the process can result in profits being counted as both ordinary income and capital gains. To correct that double counting, the tax preparer can make an adjustment on Form 8949 [3].
4. Understand What Happens in Case Your Employer Is Acquired
Businesses are bought, sold, and merged with other companies all of the time. When that happens, there is a wide range of events that may impact your stock options:
- You may be able to trade them for an equivalent number of shares in the acquiring company.
- You may be offered the equivalent of a cashless exercise.
- Your current company’s vesting schedule may greatly accelerate.
- The purchase window for your current company may shorten.
- A combination of any of the above.
In these circumstances, it will be helpful to pay close attention to any news or memos about the negotiations. Work with a financial professional to weigh each of the choices you’re offered so that you’ll do what’s best for your overall financial situation.
5. Exercise Your Options Long Before Leaving the Company
If you ever separate from your employer (and each of us will do that at some point in the future), you will need to know exactly how long you have until the remaining options must be exercised. For most companies, you’ll have 90 days — which is not a lot of time.
In that situation, you will have to make decisions quickly. Not exercising the stock options could mean losing thousands of dollars. On the other hand, exercising them on short notice could trigger a substantial tax bill. For these reasons, it is important to discuss potential avenues with an advisor before separating from your employer.
Taxation of Stock Options: Maximize Your Financial Capital
Stock options can be a major benefit to your portfolio, but not at the expense of spending unnecessary amounts in taxes. SYM Financial knows that wealth management isn’t a one-size-fits-all process and that employees with significant equity compensation may need special strategies to balance these assets with their overall portfolio goals.
To find out more about how SYM Financial can help you with your stock options, call a member of our team today.
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Disclosure: The opinions expressed herein are those of SYM Financial Corporation (“SYM”) and are subject to change without notice. This material is not financial advice or an offer to sell any product. SYM reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. This blog is for informational purposes only and does not constitute investment, legal or tax advice and should not be used as a substitute for the advice of a professional legal or tax advisor. Information was obtained from third party sources which we believe to be reliable but are not guaranteed as to their accuracy or completeness. SYM is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about SYM including our investment strategies, fees, and objectives can be found in our ADV Part 2, which is available upon request.
