Sharing your company’s success through employee stock options is a great benefit. But, if you don’t manage the tax consequences of stock compensation properly, you erode your reward for hard-won achievements.
Employees eligible for stock compensation are often the best and the brightest members of talented teams who help San Francisco businesses innovate. So, it’s not surprising that many stock compensated employees attempt to do the tax analysis and develop a tax and investment plan on their own. However, the tax landscape for stock compensation is complex and shifting, so attempting to manage your benefits without professional guidance can lead to disappointing results.
Your employee stock options (ESOs) might be your nest egg for retirement or the down payment on a house. Wherever they fit into your financial picture, a San Francisco stock compensation advisor from Marin Wealth Advisors (MWA) can help you make the most of your stock compensation.
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The best investment strategy is built on deep knowledge of financial markets and financial instruments. Marin Wealth Advisors can provide the data points you need to make critical decisions about managing your stock compensation. We put your financial future in your hands by giving you the support you need to make informed decisions.
A stock compensation advisor can help you understand:
- The effects of different stock compensation management options on your tax liabilities
- Whether to maintain a concentrated ESO position or place your savings into a diversified portfolio
If you choose to diversify, you can build wealth through a portfolio with a variety of investment vehicles, including mutual funds, exchange traded funds, and environmental, social and governance (ESG) investments.
Understanding Stock Compensation Taxes
Each type of stock compensation has different tax implications, so let’s start with a review of how taxes affect the most common types of employee stock options.
Incentive Stock Options (ISO)
ISOs follow specific guidelines from the IRS and, as a result, have a special tax status. Sales from incentive stock option plans can be eligible for long term capital gains tax rather than your marginal income tax rate which is likely to be higher than the capital gains rate. ISOs held for a minimum of one year and two years after the grant qualify for long-term capital gains.
Taxes on an ISO sale vary by income tax bracket and can be considered either short-term or long-term capital gains depending on how long the stock was held post exercise. However, ISOs can also be eligible for the Alternative Minimum Tax (AMT) calculation, and many people put themselves in grave jeopardy.
Exercising an ISO can trigger the AMT, which is a critical factor for people working or living in San Francisco because high property and state income taxes aren’t deductible under AMT. A stock compensation advisor can review your complete financial picture to help you understand how AMT might affect you and how to exercise your ISOs while mitigating the tax impact. Marin Wealth Advisors has helped many clients avoid AMT issues.
When you work with a MWA advisor, you can work toward your financial goals while strategically taking gains from your ISO plan to minimize the bite taxes take from your stock compensation.
Employee Stock Purchase Plans (ESPP)
Employee stock purchase plans let you buy stock from the company where you work, discounted as much as 15%, with automatic paycheck deductions. An ESPP can be a great way to build your investment portfolio and grow your wealth with help from your employer.
At the point where you convert all or a portion of an ESPP share purchase to a different asset or cash, you’ll pay income tax on the price discount you received on the date of purchase. You may also owe capital gains taxes if the stock increased in value, and if the value decreased, you might be able to declare a loss.
Tax planning before you sell ESPP shares can lead to significant savings. First, the long-term capital gains tax rate is significantly lower than the short-term rate. Second, holding ESPP shares for at least two years from the grant date and one year from purchase will reduce the amount on which you must pay income taxes.
Nonqualified Stock Options (NSO)
The spread in an employee stock option is the difference between your purchase price and the stock’s market valuation on the day you buy it. In an NSO plan, you owe income tax on the spread when you sell your stock. However, because NSO stocks rarely have a market valuation, you’ll probably pay income taxes on the option’s value on the grant date.
Restricted Stock Units (RSU)
Because RSUs have a vesting period, you don’t pay income taxes on this employee benefit until the tax year in which your shares fully vest. You may also owe capital gains taxes when you sell or be able to claim a capital loss.
Maximize compensation by minimizing taxes and penalties
When you sell employee stock options can make a significant difference in the amount you have to diversify your portfolio.
For example, if $10,000 of your stock compensation is subject to capital gains, a long-term capital gains tax rate of 15% would be $1,500, leaving you with $8,500 to invest. If your sale is subject to the short-term capital gains tax rate, that’s the same as your income tax rate and probably much higher than 15%. If you’re in the 35% tax bracket, you’ll pay $3,500 in taxes, leaving you $6,500 to invest.
A stock compensation advisor can help you craft a tax strategy to fit your situation and goals. A personalized plan is an excellent way to increase your savings and build long-term wealth.
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.