This can be a confusing part of your compensation package. So much so that it’s often overlooked or executed via a sub-optimal strategy due to lack of education. Let’s break down some key details related to stock & executive compensation plans:
- Employee Stock Options (NQSOs and ISOs)
- Restricted Stock (RS and RSUs)
- Non-Qualified Deferred Compensation (409a Plan)
- Employee Stock Purchase Plan (ESPP)
Did You Know: Over 10% of in-the-money options expire every year?
What an unfortunate WASTE! Why is that?
- The company documents are confusing.
- Employees are unfamiliar with the process.
- The company didn’t inform the employees of planning opportunities.
- The employee prefers not to address or procrastinates.
- The employee maintains behavioral biases such as:
- Overconfidence – Overvalues company holdings.
- Status Quo – Avoids making changes.
- Home Country – Prefers to invest in what’s familiar.
- Endowment – Considers stock more valuable because it’s already in your possession.
The Need for Advice: Objectives & Strategies
Here are the reasons why it’s imperative to have a trusted resource just a phone call away:
- Preserve Wealth
- Maximize Value of Holdings
- Provide Liquidity
- Minimize Income Tax Impact
- Produce Current Income
- Efficient Wealth Transfer
- Fulfill Charitable Intent
Discovery Questions – Let’s Start Here
These are the questions we ask before developing an execution strategy:
- What are your primary objectives for these assets? How will these assets be used?
- How do you see your role at your company changing? What’s your exit strategy for these positions?
- What’s your view on the direction of your company stock? What about tax rates?
- If you didn’t work at your company, would you own your company’s stock? How much?
- If your company gave you cash equal to the value of your current stock position, how much would you allocate to your company stock?
- What’s more upsetting: selling shares that continue to rise or holding onto shares that continue to fall?
Single Stock Exposure: What’s the Risk?
- Your company stock increases your concentration risk, exposing you to volatility that exceeds the market. Are you aware of this? Are you being paid for this additional risk?
- Let’s manage the security-specific risk through diversification!
What’s the Difference Between These Plans?
In recent years, stock-based performance awards have replaced stock options as the most prevalent form of equity-based pay. Why? Options only provide value if the shares go up, whereas restricted stock provides intrinsic value.
Although employee stock options (ESOs) are decreasing in issuance, Non-Qualified Stock Options (NQSO) are more common than Incentive Stock Options (ISO).
Restricted Stock (RS) vs. Employee Stock Options (ESOs)
Top 3 Differences:
- RS has intrinsic value, dividends, and voting rights.
- Triggering Event: RS is on the vesting date; ESO’s is at exercise.
- Tax Treatment: RS is ordinary income; ESO’s are ordinary income (NSO’s) or potential long-term capital gain treatment (ISO’s).
ESO’s: Non-Qualified Stock Options (NQSOs) vs. Incentive Stock Options (ISOs)
Top 3 Differences:
- Transferability: ISO’s are non-transferable except at death; NQSO’s are transferable.
- Grant Limit: ISO’s are limited to the $100K rule; NSO’s no limit.
- Tax Treatment: ISO’s are subject to AMT and have potential long-term capital gains treatment; NQSO’s are subject to ordinary income.
Restricted Stock (RS) Awards vs. Restricted Stock Units (RSUs)
Top 3 Differences:
- Dividends: RS dividends are subject to ordinary income; with RSU’s, you aren’t entitled to dividends until vesting date but employers may pay out dividend equivalents, which are taxed at ordinary income tax rates.
- Voting Rights: RS yes; RSU’s no.
- Early Exercise: RS is 83(b) eligible; RSU’s are not eligible.
Non-Qualified Deferred Compensation Plans (409a Plans)
Top 3 Things to Know:
- You make an irrevocable election to defer additional compensation above IRS limits established on qualified plans to go into your tax-deferred bucket.
- These plans do not receive ERISA protection and are considered an unsecured loan subject to company bankruptcy.
- A rollover option is not available, and triggering events vary; required minimum distributions (RMDs) are required at age 72.
Employee Stock Purchase Plans (ESPPs)
Top 3 Things to Know:
- You can purchase company shares on a regular basis through ongoing payroll deductions, typically at a 15% discount; some plans offer a “look back” provision to purchase stock at the lesser of two prices.
- Participation is voluntary; must meet eligibility terms.
- The IRS cap is $25K per calendar year.
Key Terms & Concepts:
- Important Dates:
- Grant date – Date award received.
- Vesting date – When you have control.
- Exercise date – When you intentionally take action to convert option award into physical shares.
- Sale date – At the time of exercise or potentially later.
- Expiration date – Applies to options.
- Commonly Used Terms:
- Strike Price/Exercise Price – Used interchangeably; fixed at the time of the award.
- Bargain Element – Represents the intrinsic value of option award (i.e., profit opportunity).
- Cashless Exercise – Facilitated by brokerage firm where they lend the client money for the exercise, the client exercises and simultaneously sells the position and pays off the loan, taxes are withheld, and the client receives a check for the net after-tax profit.
- In-The-Money/Out-Of-The-Money – ITM is an option with a strike price less than the current stock price; OTM is an option with a strike price that exceeds the stock price and therefore has no intrinsic value.
- Qualifying disposition – Only available for ISOs; an opportunity to convert award to receive LTCG rates instead of ordinary income. Must hold for 2 years from grant and 1 year from date of exercise.
Overwhelmed? Call us when you’re ready to optimize your stock & executive compensation options.