Stock compensation is a fantastic way for companies to allow employees to profit from the organization’s success. But stock options can trigger unforeseen tax liabilities that diminish your gains.
Often, stock compensated employees attempt to do their own analysis, without professional guidance, and end up with costly negative tax and investment results.
Whether you’re a tech worker or in another industry that offers stock compensation, Marin Wealth Advisors can provide expert advice and advanced tax planning assistance to reduce your tax burden and avoid surprise tax bills.
Get Personal Guidance from Expert Stock Compensation Advisors in the Bay Area
How Are Employee Stock Options Taxed?
The tax impact of your stock compensation will depend on the type of stock option plan. For example, when you exercise nonqualified stock options, you’ll pay income tax on the difference between the price you paid and the market value on the date you exercised your options or on the spread if the fair market value can’t be determined. Plus, you will owe capital gains taxes on any gains from the sale of your NSOs. But holding onto the stock for at least one year can reduce your capital gains tax rate.
On the other hand, exercising incentive stock options doesn’t necessarily result in additional taxes, at least not right away. If you hold your ISOs for long enough after both the grant date and your exercise date, you can pay capital gains taxes on the profits when you sell, which may be lower than your income tax rate.
As you can see, decisions about the wisest way to take advantage of stock compensation are complex. You can’t simply follow the plan that worked for your coworker because your tax situations are probably different. The best option for you will depend on your tax bracket and your financial situation.
Fortunately, you don’t have to do it alone. Your personal advisor at Marin Wealth Advisors can talk you through your options and help you develop a plan. Our Bay Area stock compensation advisory team has a wealth of experience. Planning is the best way to leverage your stock compensation to build wealth and enhance your financial security.
Three Ways People Who Are Good with Money Manage Their Stock Compensation
Much of Silicon Valley operates on some variation of the old Facebook motto, “Move fast and break things.” That philosophy might help birth the next innovation, but it isn’t the right way to manage your stock options.
Here are three things smart people do to maximize the benefits they get from stock compensation.
Plan Ahead to Optimize Your Options
Stock options are deferred compensation, even when you’re fully vested. To minimize your taxes and optimize your stock options, plan when to exercise and sell your stock.
Pay the Taxes Before Buying the Lamborghini
Stock options can feel like free money, but they have significant tax implications that can affect your financial stability. If you plan to sell stock for a down payment on a house or splurge on something for yourself, it’s essential to factor in the taxes. The Lamborghini will be less fun with a tax lien on it.
Don’t Go It Alone
You may be one of the best and brightest, but a DIY spirit can lead to trouble when you try to figure out the tax impact of employee stock options on your own. Savvy money managers know when expert advice is a good investment.
Plan Before You Exercise Your Stock Options
Exercising stock options without advance planning can take a bite out of your benefits. We help you get the most out of your employer’s stock plan by anticipating and planning for tax liabilities before you cash in.
Personalized guidance from Marin Wealth Advisors can help you to:
- Establish a budget to save the funds needed to exercise options
- Generate liquidity to pay additional taxes that may result from grant, exercise, or vesting
- Set salary deferral targets in ESPPs as part of an overall budget
The Most Common Types of Stock Compensation
Marin Wealth Advisors can help you with even the most complex stock compensation plan. However, most employers offer one of these four plan types:
Incentive Stock Options
- Nonqualified Stock Options
- Restricted Stock
- Employee Stock Purchase Plans
Incentive Stock Options (ISO) and Taxes
ISOs get preferential tax treatment and must adhere to special conditions set forth by the Internal Revenue Service. When you sell stock from an ISO plan, you’ll owe either short or long-term capital gains taxes based on the gain. The capital gains tax rate is lower than ordinary income tax rates for long-term gains; it is currently between 15% and 23.8%, depending on your income tax bracket.
Your stock sale can qualify for the long-term capital gains rate if you hold the shares for at least a year after exercise and two years after grant. Otherwise, your gains will be subject to the short-term capital gains rate, which is the same as ordinary tax rates. The short-term capital gains tax rate usually ranges from 25% to 39.6%, so understanding the dates to exercise and sell your ISO shares can make a significant difference in the amount you realize from your stock compensation.
Depending on how much you have invested in ISOs, failing to make a tax plan when exercising your options could cost you—a lot. [box or pull quote] Suppose you sell $1,000 of ISO stock. If you hold your shares long enough to qualify for the long-term capital gains rate, you’ll owe between $150 and $238 in taxes. However, if you sell too quickly, you’ll have to pay a minimum of $250, up to $396 in taxes. That adds up to an extra bite of up to $158 from your $1,000.
Alternative Minimum Tax (AMT) and ISOs
AMT is a huge consideration for when you exercise ISOs in California. That’s because the spread between the fair market value at exercise and the strike price of the ISO creates an AMT tax adjustment. We like to refer to AMT as the Maximum Mandatory Tax because if it is larger than the regular tax, you must pay the AMT. In addition, Californians pay high state income taxes and local property taxes, which are not deductible under AMT.
If you live in California and have an ISO plan at your work, we’re here to help you understand how the Alternative Minimum Tax will impact you.
Nonqualified Stock Options (NSO)
NSOs do not receive the same preferential tax treatment as ISOs. When you purchase stock (by exercising options) in an NSO plan, you’ll pay regular income tax rates on the spread between the purchase price of the stock and the market price of the stock at the time you bought it. In the rare instances where NSOs have a readily determinable fair market value on the grant date, you’ll be taxed on the value of the option at grant.
Restricted Stock Units (RSU)
RSUs are shares that you don’t get outright. Instead, they vest over time during your employment. The vesting period also delays when you must pay taxes on the stock. Once you’re fully vested, you will pay income tax on the value of the RSUs in the year in which they vest. If your RSU stock goes up or down in value by the time you sell it, you’ll owe capital gains tax or be able to declare a capital loss.
Employee Stock Purchase Plans (ESPP)
ESPPs allow employees to buy company stock at a discount of up to 15%. In most cases, your ESPP purchases will be deducted from your paycheck automatically, and your employer will buy the stock for you.
When you sell shares purchased through an ESPP, you’ll owe income tax on your discount (the difference between the price you paid and the price of the stock on the day it was purchased). Any additional gains will be taxed as long-term or short-term capital gains, depending on how long you hold the shares.
ESPPs have an additional tax wrinkle: if you hold your shares for at least two years after the grant date and at least one year after they were purchased, you only owe income taxes on a portion of your discount. If you buy stock through an ESPP, it’s essential to get tax planning help before exercising your options.
Marin Wealth Advisors is here to help you:
- Review the different tax consequences of ISOs, NQSOs, RSUs, and ESPPs
- Develop strategies to minimize your tax liability
Tax Planning is an Investment in You
Building wealth often begins with a small step, like seeking professional advice on managing your employee stock options rather than trying to figure it out yourself.
Marin Wealth Advisors provides affordable, fee-based investment services that help you invest in your future.
Get Help to Make Educated Investment Decisions
You don’t have to be a financial genius to make better decisions about your employee stock options. At Marin Wealth Advisors, we give you the information you need to make the decisions that improve your financial health and help you build wealth.
We’ll review all your options, including:
- Pros and cons of retaining concentrated employer stock positions vs. diversifying to a global portfolio
- The merits of your investment decisions weighed against tax consequences
- Various investment options are available to diversify concentrated stock positions, such as:
- Individual stocks and bonds
- Index funds
- Mutual funds
Free Stock Compensation Tax Review for ESPPs, ISOs, NQSOs, and RSUs
You don’t have to navigate the complexities of stock options taxes on your own. Marin Wealth Advisors offers a free one-hour compensation plan review meeting to get you started. You’ll meet in person with one of our advisors to assess your situation. We are expert stock compensation advisors who listen.
Whether you want to use your stock compensation to build your retirement fund or cover your everyday expenses, Marin Wealth Advisors can show you how to use your options to meet your financial goals.
Before our first meeting:
- Gather the documents for your equity grant package
- Prepare a list of questions you want to discuss
We’ll do the rest!
We can’t write a line of code. But we can help you create a plan to get the most out of your stock compensation.
Trust the experts: Marin Wealth Advisors.
Marin Wealth Advisors LLC is not a CPA or tax preparation firm.
We work closely with our clients’ CPAs and tax professionals to provide the best possible financial planning and investment advice.