What Issues Should I Consider Regarding My Non-Qualified Stock Options?

Non-Qualified Stock Options (“NQSOs”) are a common form of equity compensation, offering a share in the potential appreciation of a company’s value. Many of our clients have been (or will be) granted NQSOs as an employee of an issuing company or as an officer, directors, contractors, or consultants. Deciding whether and when to exercise NQSOs and sell shares can be difficult and requires cash flow analysis, complex tax planning, and a long-term strategy.

This checklist helps guide your conversations when advising clients regarding their NQSOs. It covers:

• Issues to consider at grant

• Implications of exercise, including early exercise and post-vesting

• Tax considerations and the IRC 83(b) election

• Share ownership and sale strategies

• Concentration and other risks

Transcript:

Hi, Todd Pouliot, Gateway Financial. Again, www.mygatewaymoney.com is our web address. And, I got a video today in much in relation to the one that we just did. This is on non-qualified stock options, contrary to what we just did in incentive stock options. Incentive stock options are entitled to potentially favorable federal tax treatment where non-qualified stock options or NQSO and sometimes NSO, are not qualified for special tax treatment. They're a common form of equity compensation, they offer a share and the potential appreciation of a company's value. And, many of our clients have been or will be granted non-qualified stock options as an employee of an issuing company or as an officer, a director, a contractor, or even a consultant. So, deciding on when to exercise these non-qualified stock options and sell the shares, it's difficult, it involves many different aspects; cash flow analysis, complex tax planning, and a long-term strategy. So, we're going to go over this flow chart here – or excuse me – the checklist and we're going to cover five main areas; issues to consider at grant, implications of exercise including early exercise post-vesting, and my favorite 83(b) election, share ownership and sales strategies, and concentration and other risks. So, as we always do, we're going to come and share our screen, show you what we're talking about here. And again, if you would like this checklist, I can email it to you if you reach out to us and I'll give you our email address a little later on. But, grant issues, do you need help understanding the options that are granted to you? So, make sure you work with your HR and your advisor and say, “Hey, what do I have here?” Make sure you understand are they an incentive stock option or a non-qualified stock option? If these are incentive stock options, this is not the checklist we should be using. Do you need help determining the tax implications at grant? That's also a great thing. Make sure you hire a qualified tax preparer, enrolled agent, or CPA like we have here in our office. We want to know, “I'm getting granted some stock options, I'm not sure if they're qualified or non-qualified, what are the tax implications?” So, the income tax is generally not due the year of the grant except in rare cases. So, we want to make sure that we understand when are those going to be taxed. And sometimes, this is a good tax planning strategy. Exercise price is less than the fair market value at the grant date. Whoa, that's not a good thing sometimes is it but we have to be careful to defer compensation tax under 409(a). So, make sure you understand these all have little tricks and how do we deal with these and when you click yes or you click no, that gives us a good angle to come at a problem at. Are you subject to a vesting schedule? Do we know what that vesting schedule is? We need to monitor the expiration of relevant time periods. A lot of people forget what those dates are. Make sure they're being monitored and note whether your options have an early exercise feature. This can be a good feature for the right situation. Just make sure you know whether or not it's an option to you. Any clawback provisions? And, part of what that clawback provision goes, “Do we need to review how termination of employment?” Voluntary or involuntary? Much like I said in our last video, I felt that the younger generations were going through the great resignation, what we're actually finding out is everybody was. So, we're learning a lot and people are quitting jobs voluntarily and involuntarily due to the situation that we have going on economically in the world. Exercise issues. Do you need help to determine the value of your interest? What was the grant price? What is this the fair market value and so forth? And, are we ‘in the money’ which is good, that means we have a positive exchange – exercised at 10, now we're selling it at 20. Or, are we ‘under water’ which is typically bad we exercised at 20 and and the fair market value today is at 10 so – or we granted a 20 excuse me. Is there a bargain element and the opportunity to share in any future stock appreciation? We want to look at some dividend policies, look at the ex-dates and find out what those are. And, any discount in the underlying shares that are not marketable? Do we need to look at the future equity value and long-term viability? Be mindful, overly financial dependent upon your employer as your sole source of earned income and potentially large percentage of your net wealth. In my last video, I gave you a little personal story on how it affected my family and I'm telling you, when I see this and I see a high concentration of wealth in the company stock, I get a little lump in my throat because I've been in the bad side of the situation. Look historically, look at Enron, look at locally National City Bank, look at all the situations where people that are highly concentrated in the company that ends up not being there when they need them most. Do you need help determining income tax limitations on those – exercising those vested options? So, the spread between the exercise price and the fair market value at exercise, you need to understand, what does that mean as far as tax and am I withholding enough tax? Do I have enough money on the sideline to pay all the tax? And, we also can look at the 83(i) election and we may be able to defer income tax for up to five years. So, tax prep is not the same as tax planning. Make sure you understand that that's a really hard line for people to understand. Tax preparation, although that word preparation sounds like prepare for the future, it actually looks backwards. Tax planning is looking forward. Are you permitted to early exercise and purchase stock before vesting? Dividends are reported as wages until vesting and ordinary income tax will not be due at exercise. So again, this is that tax planning. What can we do? Ordinary income tax will be due on the bargain element. And, that bargain element that's the key that we're always looking for. How much of a bargain am I getting? We've seen some – they’re buy one get one free. That's a wonderful deal. So, we need to make sure that that bargain element – how do we take care of that with taxation? And, do you lack the funds necessary to do a cash exercise? I hope that's not the situation, but if it is, there are planning strategies. There are favorable alternatives including borrowing, a cashless exercise, or a stock swap. Be aware the tax consequences again with those issues that are out there. Do you own unvested shares due to an early exercise? Do you need help determining the basis of your shares? That is a huge one. I will tell you, the amount of times I shake my head looking at 1040 returns from the prior year and they list that cost as zero. And, if you want to pay more tax than your fair share, that's an easy way to do it so make sure you understand the basis of those shares. And, ask for help, “Hey, I don't know the exact – can you help me figure this out?” There are tools to help you do that. Understand the tax consequences of the sale of shares acquired through your options. And, you require a pre-clearance or have a blackout window that might affect your ability to trade your shares. Make sure whomever is actually pulling the trigger understands those blackout periods that may be affected. And, some last final issues. Do you need to increase your withholdings beyond any employer withholdings for these tax on your options? Do you need a plan to mitigate concentration risk? And, that's one of the things that we just spoke about earlier. Don't put all your eggs in one basket. “I know, well I know this company, I know they're going to do well.” Sometimes, if you're not sitting in the highest level of those meetings, you may not know the full truth. Embezzlement and other things have happened or you know, just a litany of issues that we don't need to talk about. So, we want to make sure that we we understand concentration risk. And also, look at the other risks on price decline. Maybe the company's not doing as well as you thought it would do in the future. Address your options in your estate plan or a pending divorce. These are very deep issues that most people don't think about when they're getting these stock options and nor do we want to we hope you have to avoid these situations. But, who ends up with those stocks and are there any dates that we have to align those stock options up with? And, any future financial goals that your options could help achieve? So, we want to make sure we give that money a purpose or those stock options a purpose. Why am I doing this? It's not just about the money it's about the purpose of that money that we want to make sure. Again, feel free to reach out to us at mygatewaymoney.com our email address is located here. And, we do now have these shareable and we appreciate you all making this recommendation for us. “Hey, you know, I really liked what you showed me but can you send me the checklist?” So, send us your email and we'll take that and we'll send it right out to you. And, we appreciate you being here. Wonderful day to talk about stock options. And remember, the difference between non-qualified and incentivized stock options and there are other ones restricted stock units and phantom stocks and so forth we'll make more videos on. But just here to help educate you all and if you feel this is a worthwhile cause, really need that thumbs-up really help us with the subscription and uh sharing our videos with others that you feel might need these. Thank you, and have a great day.