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Company Stock Options

Company Stock Options    All the many companies and their stock options

What you need to know?

Employee stock options are no longer just for the executive suite.
From cash-poor Silicon Valley start-ups to old-line manufacturing and service firms, more and more companies are offering stock options to the rank and file as well.

ESO's are very popular today.
The National Center for Employee Ownership estimates that employees control 8.3 percent of total U.S. corporate equity, or $663 billion, up from less than 2 percent just a decade ago. Employee stock-option plans account for at least $200 billion of that total.

More workers are getting stock options.
Ten years ago there were only about 1 million workers covered by a few hundred stock option plans. Today there are probably seven times that many employees participating in some 3,000 plans.

Get to know these common terms.
An employee stock option gives you the right to buy ("exercise") a certain number of shares of your employer's stock at a stated price (the "grant," "strike," or "exercise" price) over a certain period of time (the "exercise" period).

The two common types of plans.
Employee stock options come in two basic flavors: nonqualified stock options and qualified, or "incentive," stock options (ISOs). ISOs qualify for special tax treatment. For example, gains may be taxed at capital gains rates instead of higher, ordinary income rates.

What are nonqualified plans?
Unlike ISOs, nonqualified stock options can be granted at a discount to the stock's market value. They also are "transferable" to children and charity, provided your employer permits it.

Exercising your options.
You can pay cash, swap employer stock you already own, or borrow money from a stockbroker while, simultaneously, selling enough shares to cover your costs.

Hold options for as long as you can.
Conventional wisdom holds that you should sit on your options until they are about to expire to allow the stock to appreciate and, therefore, maximize your gain.

Some reasons to exercise early.
Among them: You have lost faith in your employer's prospects; you are overdosing on company stock; you want to lock in a low cost basis for nonqualified options; you want to avoid catapulting into a higher tax bracket by waiting.

Tax consequences.
Unlike with nonqualified options, an ISO spread at exercise is considered a preference item for purposes of calculating the dreaded Alternative Minimum Tax (AMT), increasing taxable income for AMT purposes.

Employee Stock Options

More companies today are handing out stock options.

Employee stock options used to be reserved for the executive suite. No longer. From cash-poor Silicon Valley start-ups to old-line manufacturing and service firms, more and more companies are offering stock options to the rank and file as well.

The National Center for Employee Ownership (NCEO) estimates that employees control at least 10 percent of total U.S. corporate equity, up from about 8 percent just a decade ago, and that employee stock ownership plans account for at least $500 billion. Ten years ago there were only about 1 million workers covered by a few hundred stock option plans. Today there are probably seven times that many employees participating in some 3,000 plans.

Still, management continues to receive the lion's share of stock option grants. Of companies that grant options to more than half their employees, non-management receives 45 percent of total options allocated, on average. At the largest companies, this average is 29 percent. At biotech and computer firms, however, 55 percent of option grants go to non-managers.

The ABCs about ESOs

The basic things you need to know about stock-option plans

An employee stock option is the right given to you by your employer to buy ("exercise") a certain number of shares of company stock at a pre-set price (the "grant," "strike," or "exercise price") over a certain period of time (the "exercise period").

Most options are granted on publicly traded stock, but it is possible for privately-held companies to design similar plans using their own pricing methods. Usually the strike price is equal to the stock's market value at the time the option is granted, but not always. It can be lower or higher than that, depending on the type of option.

Employees profit if they can sell their stock for more than they paid at exercise. NCEO estimates that employees covered by broadbased stock-option plans receive an amount equal to between 12 and 20 percent of their salaries from the "spread" between what they pay for their option stock and what they sell it for.

Most stock options have an exercise period of 10 years. This is the maximum amount of time during which the shares may be purchased, or the option "exercised." Restrictions inside this period are prescribed by a "vesting" schedule, which sets the minimum amount of time that must be met before exercise. With some option grants, all shares vest after just one year. With others, 20 percent of the total shares are exercisable after one year, another 20 percent after two years, and so on. This is known as "staggered" or "phased" vesting. Most options are fully vested after the third or fourth year, according to a recent survey by consultants Watson Wyatt Worldwide.

Whenever the stock's market value is greater than the option price, the option is said to be "in the money." Conversely, if the market value is less than the option price, the option is said to be "underwater."

During times of stock market volatility, a company may "reprice" its options, allowing employees to trade in underwater options for in-the-money options. For example, if options were originally exercisable at $50 and the stock's market price dropped to $30, the company could cancel the first option grant and issue new options, possibly fewer than originally granted, exercisable at the new $30 share price. Investors generally frown upon this practice.

The Different Types of Options

The way a plan is set up can make a big difference to the value of the options

Nonqualified stock options

After that, any subsequent appreciation in the stock is taxed at capital gains rates when you sell. Keep the stock for more than a year and you'll have a long-term capital gain, taxed at a top rate of 20 percent; hold for one year or less and your gain is short-term, taxed at higher, ordinary income tax rates. Nonqualified options can be granted at a discount to the stock's then market value. They also are "transferable" to children and to charities, provided your company permits it.

Incentive stock options (ISOs)

These are also known as "qualified" stock options because they qualify to receive special tax treatment. No income tax is due at grant or exercise. Rather, the tax is deferred until you sell the stock. At that point, the entire option gain (the initial spread at exercise plus any subsequent appreciation) is taxed at long-term capital gains rates, provided you sell at least two years after the option is granted and at least one year after you exercise.

ISOs give employers no tax advantages and, so, generally are reserved as perks for the top brass, who tend to benefit more from ISO's capital gains tax treatment than workers in lower income tax brackets. High-paid workers also are more likely than low-paid workers to have cash to buy the shares at exercise and ride out the lengthy holding period between exercise and sale.

If you don't meet the holding period requirements, the sale is a "disqualifying disposition" and you are taxed as if you had held nonqualified options. The spread at exercise is taxed as ordinary income, and only the subsequent appreciation is taxed as capital gain.

Unlike nonqualified options, ISOs may not be granted at a discount to the stock's then market value, and they are not transferable, other than by will.

Two warnings apply here:

1. No more than $100,000 in ISOs can become exercisable in any year.

2. The spread at exercise is considered a preference item for purposes of calculating the dreaded Alternative Minimum Tax (AMT), increasing taxable income for AMT purposes. A disqualifying disposition can help you avoid this tax.
   

Exercising Your Stock Options

Cashing in your stock options may not be the smartest thing to do

How to exercise

There are three basic ways to exercise options: pay cash, swap company stock you already own, and engage in a "cashless exercise."

• Cash: This is the most straightforward route. You give your employer the necessary money and get stock certificates in return. But what if, when it comes time to exercise, you don't have enough cash on hand to buy the option shares and pay any resulting tax?
  

• Stock swaps: Some employers let you trade company stock you already own to acquire option stock. Say your company stock sells for $50 a share and you have an ISO to buy 5,000 additional shares for $25 each. Instead of paying $125,000 in cash to exercise the option, you could exchange 2,500 shares (with a total market value of $125,000) you already own for the 5,000 new shares. This strategy has the additional benefit of limiting your concentration in company stock (see below). Note: You must have held the swapped ISO shares for the required one- and two-year holding periods to avoid having the exchange treated as a sale and, thus, incurring tax.
  

• Cashless exercises: This is where you borrow from a stockbroker the money needed to exercise your option and, simultaneously, sell at least enough shares to cover your costs, including taxes and broker's commissions. Any balance is paid to you in cash or stock.

When to Exercise

 Although conventional wisdom holds that you should sit on your options until they are about to expire to allow the stock to appreciate and, therefore, maximize your gain, many employees can't stand to wait that long. One study found that the typical employee cashed out of his options within six months of becoming eligible to do so, thereby sacrificing an estimated $1 in future value for every $2 realized.

Of course, there are legitimate reasons to exercise early. Among them: You have lost faith in your employer's prospects and, therefore, its stock. You are overdosing on company stock. (It is generally imprudent to keep more than 10 percent of your portfolio in employer stock.) A quick way to estimate the value of your options is to calculate how much you would pocket after exercising them and immediately selling the shares, ignoring taxes for simplicity.

You want to lock in a low cost basis for your nonqualified options. Since the spread at exercise is taxed as ordinary income, it might make sense to exercise early so you can take most of your earnings in stock appreciation, taxed at lower, capital gains rates.

You also want to avoid getting pushed into a higher tax bracket. Waiting to exercise all your options at once could do just that. Exercising a portion at a time can alleviate this problem.

 Company Stock Options