Stock Options

Rewarding Your Contributions and Effort

For decades, stock options have been used by companies as a reward for employees. Stock options are a benefit or form of compensation that provides employees with ownership of their company and a financial incentive to help the company do well.  For many years, the term equity compensation was synonymous with employee stock options, and it was one of the most widely used forms of equity that was granted to employees.

“Educated investors are the most successful investors,” is something we have long believed at TCI. That’s why we’re providing you with some resources as you start your stock option journey.

Key Stock Option Terminology

• Grant Date – The date your company grants employees stock options.
• Strike Price (Exercise Price –) The fixed price at which you can purchase shares of company stock through your options. This price is set on the grant date, however, there are circumstances that could change the strike price.
• In-the-Money Value (ITMV) – The value of your stock option when the current stock price is higher than your strike price. This is the true value of your stock option which is calculated by taking the difference between your strike price and the current value of the stock.
• Expiration Date – The date when you must exercise your options, often 10 years from the grant date.

Exploring Your Options: NQSOs and ISOs

An important part of your financial journey with stock options is understanding which type of options you have. This will help you determine the role they can play in fulfilling your long-term financial goals.

• Non-Qualified Stock Options (NQSOs): Stock options that can be granted to employees, contractors, or board members. When you exercise NQSOs, you pay taxes on the difference between the stock’s fair market value and the strike price as ordinary income. There are multiple different ways to exercise your NQSO options.
• Incentive Stock Options (ISOs): Granted only to employees, these stock options offer favorable tax treatment if certain conditions are met. If required conditions are met, gains from ISOs are taxed as long-term capital gains as opposed to ordinary income. One difference being that when you exercise your stock options, you can potentially subject yourself to Alternative Minimum Tax (AMT).

ISOs and Tax Benefits

As mentioned, ISOs come with tax advantages and unique rules. Here is an overview of what to consider when exercising your ISO options.

• Qualified vs. Non-Qualified Dispositions: When selling stock acquired through ISOs, a qualified disposition means you’ve met the required holding periods set by the IRS (at least two years from the grant date and one year from the exercise date). If you sell before meeting these holding requirements, it’s considered a non-qualified disposition.
• Alternative Minimum Tax (AMT): A tax system ensuring that people with higher incomes pay a minimum amount of taxes, even if they have many deductions. If you’re exercising ISOs, the AMT might apply. You could pay extra taxes on the difference between the stock’s current price and what you paid for it, even if you haven’t sold the stock yet.

Stock Option Tax Implications

Exercising stock options creates a taxable event, and the type of option, ISO or NQSO, determines how the taxes are treated. With stock options as a part of your long-term plan, your team will continuously be aware of and planning for the tax implications they pose.

While we are not CPAs and this should not be taken as tax advice, TCI’s equity compensation team is here to help you make the most of your stock options. We’re also available to collaborate with your CPA to help you prepare for key tax events, such as taxable income at exercise, capital gains upon sale, and potential AMT (Alternative Minimum Tax) liabilities. With proactive planning, we aim to reduce the risk of unexpected tax bills and keep you on track to meet your goals.

Building Your Stake Over Time

Understanding your vesting schedule is another critical component of your stock options. Vesting refers to the timeline over which you gain the right to exercise your options. Common types of vesting include:

• Cliff Vesting: All options are received at once after a certain period.
  Graded Vesting: Stock option ownership accumulates over time and there is no initial cliff.
• Cliff/Graded Vesting: A combination vesting schedule where you have to satisfy a longer period (ex: 1 year) to receive the first vest (the cliff) and then shares start vesting on a graded schedule (ex: quarterly after the 1 year cliff).

If early exercise is available to you, we can help you understand how this option could fit your financial strategy.