Wednesday, April 4, 2012

Stock Options - the (Very) Basics

Working Wednesday, a chance to make a difference in the marketplace.

In the game of life...
What if you are fortunate to work for Blue Sky (for example), a company that has publicly traded stock, and your employer has employee stock options?  Is this something you ought to be interested in - is it a good deal for you?  This question popped up this past week, so let's take a look and see what is going on.

Your stock option gives you the right to purchase shares of your employer's stock at a given price.  The option also tells you the number of shares you are eligible to buy.  You may also be allowed to make purchases at a future date, but not indefinitely - they generally expire.

Terms to know:

  • Grant Date = the date you receive the option
  • Exercise Date = the date you purchase the stock
  • Disposition Date = the date you sell the stock

sometimes the market is up...
If certain requirements are met, these options are called "statutory stock options," either Incentive Stock Optioins (ISOs) or Employee Stock Purchase Plans (ESPPs).  Statutory stock options are a good thing because they can produce capital gains instead of ordinary income when you eventually sell, assuming you sell the stock for more than you bought it for.  Capital gains / losses are generally taxed at a more favorable rate.

So the idea is to exercise the options, then sell the stock at a gain.  Before you do, though, you have to hold the stock for at least:
  • two years from the grant date, and
  • one year from the exercise date
Otherwise, part of the sale is ordinary income.

For ESPPs, you may get an option to buy for a price lower than what the stock is trading for at the time.  That's good, because you are buying at a discount!  In other words, if Blue Sky is selling for $100, and your grant is for $75, you're already ahead.  In this case, you have $25 of ordinary income that you will see on your W-2, and later, when you sell the stock, your capital gain (or loss) is based on a $100 purchase price.

and sometimes down.
For ISOs, the same situation above.  The $25 difference does not become ordinary income until you sell the stock.  Unless the stock sells at a loss, then it is all capital loss.

There is more to be said.  All the "what ifs" would make this too long of a post, so here are your stock option take aways:
  • An option means you can buy stock for whom you work for.
  • You could even buy stock at a discount.
  • If you do, now you are in the stock market, and you have the chance to sell for gain or loss.
  • Use tax planning to make sure you pay tax at more favorable rates.

Thanks to QUICKFINDER, and JK Lasser's YOUR INCOME TAX for being my primary resources for this post.  Remember, this is only general information and not tax advice in the "consult your tax advisor" sense.  Tax advice that applies to your situation you pay for.  This is a general post and it is free of charge.

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