Saturday, June 24, 2000
Personal Finance
Taxes can be tough on options
I have recently joined an Internet start-up where I will receive a large chunk of stock options as part of my compensation package. One quarter of these options will vest within a year, with a fraction vesting every month from then on. What's the best strategy tax-wise to deal with these? Would a foundation or trust help?
What a good question, especially considering the amount of options being doled out these days at dot-coms around the country.
According to the National Center for Employee Ownership, as many of 10 million employees now get stock options — up from 1 million in the early 1990s.
And while everyone seems to like them, few people seem to understand them.
“This area is so doggone confusing,” said Crystal Faulkner, a downtown accountant who works with several Internet start-ups.
Qualified options
First, understand that your stock options are probably different from those of P&G's John Pepper or Disney's Michael Eisner. Besides not being potentially worth millions of dollars, they are taxed differently.
The options that Mr. Pepper or Mr. Eisner are given are called “qualified,” or incentive options. Executives are given the right to buy company stock at a certain price, the so-called strike price. That gives them incentive to get the stock above that strike price so they can profit on the difference.
The government treats qualified stock options as if they were regular stock. Tax depends on timing: If you hold the stock for two years after getting the option and 12 months after getting the stock, any gain will be taxed at the lower capital gains rate.
Nonqualified options
But the tax treatment on options given in exchange for services is much more unfavorable. These options, also given as part of a compensation package, are called “nonqualified” options.
Nonqualified options can be taxable to you in the year they are given — but only if the option itself can be traded on a public exchange, like the Chicago Board Options Exchange.
But few Internet start-ups are public companies, and fewer yet have their options traded. Therefore, your nonqualified options aren't taxable until you actually exercise the option.
At that point, you recognize ordinary income on the difference between the strike price and the fair market value on the date you exercise the option. But because the company is private, a valuation must be performed to determine that amount that can be included as income.
You could contribute the stock to a charity or a charitable trust and get a tax deduction, but you also would forego the financial gain from the stock. Your deduction would offset your income, and your net benefit would be zero.
Financially at least. You'll still feel good about giving to charity.
Amy Higgins writes about personal finance for The Enquirer. You can reach her at (513) 768-8373; ahiggins@enquirer.com; or Your Money, The Cincinnati Enquirer, 312 Elm St., Cincinnati 45202.
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