Understanding Company Stock Options Part 2

We break down how employee stock options actually work, from strike price and vesting to the moment taxes show up on your W-2. We also explain how exercise timing, holding periods, and cashless exercise can change your real take-home value. 

• Stock options versus RSUs and why options give you control over timing 
• Strike price, vesting schedules, and why the strike price stays fixed 
• Expiration timelines and why waiting can be a feature and a risk 
• NSOs versus ISOs and why the tax rules differ 
• How the spread at exercise becomes ordinary income for NSOs 
• The 365-day rule and short-term versus long-term capital gains 
• Why your tax bracket and other income change the best exercise plan 
• Using lower stock prices to reduce the taxable spread 
• Cashless exercise mechanics and when it may help 
• Why a personalized plan beats copying a coworker’s strategy 

To learn more about Stansell Wealth Planning visit:
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Stansell Wealth Planning
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469-606-2040

Transcript

Welcome And What We Cover

Speaker 0:16

Hey everyone, welcome back to the Stansell Wealth Planning Podcast. I'm your host, Cody Stansell. Hope your summer is off to a great start. It is cooler and not as hot as it normally is, so I'm definitely taking that. The only caveat is it's been raining too much that I haven't been able to play as much golf as I'd like because it's too been too wet. But I hope you are doing well wherever you are. If you are new here, this is where we go over all the different financial planning aspects that affect your money. So investments, taxes, stock compensation plans at work, insurance, estate planning, all the different areas that affect your money. Today is this part two of our two episode series on stock compensation. So last

Stock Options Basics And Strike Price

Speaker 1:05

week we talked about restricted stock units, performance stock units, employee stock purchase plans as well. But today we're going to talk stock options. Okay. I feel like I talked to a lot of people that's been the running, everyone's heard of stock options, but don't really know exactly how they work. Once again, and I said this last week: if you do not have any stock compensation plans at work, if you don't have any stock options, RSUs, PSUs, this might be an incredibly boring episode for you, or you might be very intrigued and want to listen in as well. So if this doesn't affect you, send it to a friend, coworker, parent, family member that does have this kind of compensation, and they'll be greatly benefited. If you do have stock options, listen here because it's going to be a great episode for you. Hopefully gain some understanding. At the end of the day, not to put the cart before the horse, but at the end of the day, everyone's stock compensation plan is a little bit different. So you if you have a buddy that works at a different company and he's oh yeah, you should do this and this with your stock options. I would not trust that at all because every plan is a little bit different, and what is best for you might not be what's best for your friend or your neighbor. Even if you and a coworker, same company, same stock option plan, but your situation in life or your income could be different. And so what you should do may even differ from what your coworker does with the exact same stock option plan. Okay, so reach out to a professional, would love it to be us, but and we can sit down and go over your particular plan. So let's dive right in. Stock options are more complex than RSUs, so restricted stock units or performance stock units. So buckle up if I lost you last week on the restricted stock plan talk. Stock options, just like the name implies, you have the option to choose your taxable event. So similar to restricted stock units, you have options, shares granted to you. So let's say you have 100 options granted to you. But different than restricted stock, you have there's also a strike price or a purchase price that comes with your stock options. So every grant will have a different will be different, but let's say your company says you have 100 options and the strike price is at $80 per share. I'm just making up these numbers. I'll share my screen and show you the spreadsheet here in a little bit to give you a visual. But they say you can buy our company stock at $80 per share. Okay. And let's say the vesting schedule is 20% over the next five years. So every single year you'll be vested in those 20 shares each year for the next five years in this example, right? Every plan's a little bit different. And so in 365 days from now, you will have the option to buy these 20 shares. Okay, remember five years, 20%. Keep in mind this strike price of $80 per share is stagnant. So it stays the same. Once they say, Yep, here's your 100 shares, here's the vesting schedule, the strike price is $80 a share. That strike price doesn't change. The actual stock price could go up and go down. It could go to $100 a share or $10 a share or $1,000 a share. But that doesn't affect what you can buy your shares at. Okay. So that's the beauty of it. That's the whole purpose of stock options. The company is saying, hey, no matter where our company stock goes, you have the right to buy this quantity of shares at $80 per share. You're welcome, right? So it's wanting you to pitch in at the company, improve company performance. Therefore, stock price goes up, therefore you benefit. That's the whole purpose. Companies send out stock options is to incentivize employees to work hard for the greater good of the company, right? So you hear me here. You don't have to buy your shares when you vest. The timing is up to you. But once those options vest, then you have the power to purchase them at any time. Okay? So keep in mind stock options can expire. Check your stock option plan for details. But most that I've seen is 10 years from grant date. So let's say you were granted March 1st of 2026. You have to strike them. You have to buy them for the next at least the next 10 years. They will expire March 1st, 2036, in this example. Okay, so it does give you a timeline, but it's usually a long runway. But just keep that in mind as

NSO Versus ISO Tax Differences

Speaker 5:52

well. Taxes. So taxes on stock options are a little confusing. Confusing. Your stock options, once the first thing when a client gets a stock option package or they start with a company that has stock options, one of the first things you want to look for are they NSOs, non-qualified stock options, or they ISOs, incentive stock options. That won't mean anything to you, but you will see either ISO or NSO on the paperwork. That means a lot to the taxes and how, because each one of those plans and how the IRS taxes, those different plans are different. NSOs are the most common. So that's what I'll go over here here in a second. So whenever you decide to strike an NSO plan and buy those 20 shares at $80 per share, you have to know what the actual stock is trading on the day that you buy them. Okay, so if your actual stock price is $130 per share on the day that you strike at $80 per share, that $50 difference, $50 per share difference is what you'll determine your taxable event and how much you'll owe. So in that example, you got to buy them at $80 a share and they were trading at $130 a share on that particular day that you strike, you struck them. It's $50 per share taxable value to you, flows through to your W-2 at work, just like restricted stock units last week. So it's think with me here. It's the chicken or the egg when it comes to stock options. Do you want your stock price to be high or low on the day that you strike or purchase your shares? Okay. The higher the stock price is, the higher your taxable event is going to be. You can buy them at $80 a share, but let's say they're worth $1,000 a share on the days you strike them. Well, that's great. But once you buy those shares, that spread is going to be what you're taxed on. And so it's not ideal, not as ideal for your stock price to be so high when you strike them, because that's what your taxable event is going to be. But once again, you don't want it to be too high because you'll just have more tax liability. Okay. So after you buy your shares, you have two options. You can keep the shares, and now you just have 20 shares of your company stock, or you can sell them. They're yours now. You can do whatever you want with them. Before you've invested or before you buy them, you can't sell them, obviously. So if you sell your shares within 365 days after the day that you bought them, if you sold them before 365 after you bought them, you just owe ordinary income taxes on the stock price above that $130 per share. Okay, so you with me here. And I'll dive into it too. I went into this last week. If you wait at least 365 days to sell your shares after you bought them or struck them, you get a better tax rate on that gain any stock price above that 130 that I showed you Edwin. So once again, reminder your certain tax rate is dictated by the other income that you have. At what tax rate are these shares at? So it depends on what your other income is. So if all your in other income from a job was $50,000 a year, let's say, you're probably in the 10 or 15% tax bracket. Okay, 10 or 12%, excuse me. So you would owe 10 or 12% on this gain, okay, this taxable event. But if you make half a million dollars a year, you're probably in the 32 or 35% tax bracket. So you'll owe 32 or 35% on this taxable event, right? But if you wait at least one year after you bought these shares to sell them, any gain above that $130, the $130 per share,

A Simple Spreadsheet Tax Walkthrough

Speaker 9:55

is taxed at a 15% long-term capital gains rate. Okay. So let me share my screen and I'll give you a visual here. And once again, if you are not watching this on YouTube and just listening, you may want to pull this up on YouTube. Nothing too groundbreaking with my spreadsheet, but it does give you a visual. Okay, so everything I just verbalized earlier, here is your situation. You were granted 100 shares of stock options, 100 options, March 1st, 2026. And they said you can buy these shares for $80 per share. That's your strike price, is what it's called. Once again, let's say the vesting period is five years. So every year you'll you will be able to buy $20 per share for the next five years until it adds up to 100 options, right? And they expire, let's say 10 years from now. So March 1, 2036. So you were granted these March 1st, 2026. Let's fast forward, it's March 1st of 2027. Your vesting schedule, yay! I have 20 options now, 20 shares that I can decide to buy the stock at $80 per share. So I can spend $1,600 to buy these shares. And once again, let's say the share price it moves every single day, right? Your $80 strike price is stagnant, but they stopped actually what the stock is trading for, it changes every day, right? It's a publicly traded stock. But let's just say the share price was $130 per share on March 1st when you decided to buy your shares. Okay. So what is your taxable event going to be? Well, you bought it $80, it was trading at $130. So that's a $50 per share difference. And let's say you struck with all 20 shares. So a $50 gain per share, 20 shares, that's $1,000. That's your taxable event. That's the taxable amount that's going to flow through your W-2. You're going to owe ordinary income tax on it, your $401K contributions, everything, like you got a $1,000 bonus, basically is how it's treated. Okay. So stay with me here. You spent $1,600 to receive a stock that's worth $2,600. Okay. So a thousand dollar gain. Let's fast forward less than a year. It's only three months, three months later. It's now trading at $140 per share. So it's grown $10 per share. You own these 20 shares, right? You bought at $80 a share. Okay. And now you owe these, you own these 20 shares. If you decide to sell your 20 shares three months later, you will owe short-term capital gains on that $10 per share difference. Right? You've already paid taxes on the difference between $130 and $80. So now it's like you bought them at $130. And so if you sell them at $140, you'll just owe a $10 per share difference. Okay. So 20 shares at $10 per share difference is $200. Okay. Now that $200 is just an ordinary income. Add it. Act like you made it in a salary from a job. The taxes are going to be the exact same. Okay. Or you wait, you strike March 1st, 2027, and you own those 20 shares, but you wait at least a year. Let's say it's March 2nd of 2028, and you say, Yeah, now I want to sell my shares. And let's say they're at the exact same price. They're at $140 a share. So you sell your 20 shares for $140 per share. The gain is the same thing. It's basically like you bought, you've already been taxed on up to $130,000. You sell them for $140,000. So you'll have that $10 per share gain. But now you owe a long-term capital gain on those that $10 per share. So once again, most of my clients are in the 15% long-term capital gain bracket. So the difference in owing, let's say, your ordinary income tax of 22% or 24% and 15%. In these examples, in these share volumes and the quantity, it's not that much, right? I said, yeah, you made 200 bucks selling the shares. So the math isn't drastically different. But I'm just making these shares smaller for hypothetical reasons, the simplicity reasons. Usually these are in the tens of thousands of dollars. So your taxes, would you rather pay 15% on a $10,000 gain or 24% on a $10,000 gain? Right? The math ends up being very different the higher the numbers get. So keep that in mind. We usually recommend when you invest in your shares, and now that you have these shares, deciding when to

Timing Your Exercise To Manage Taxes

Speaker 15:10

strike, when to buy those options is dictated on your personal situation. Right? What tax bracket are you in? Do you need the cash right now? What season of life are you in? It really depends on all of that. So once again, all of this example was for NSOs, non-qualified stock options. If you don't have NSOs, if you have ISOs, incentive stock options, just call us. It's too complicated to go over in a 20-minute podcast episode. But basically, you have to watch out for another tax law. It's called AMT, alternative minimum tax. If you exercise an ISO, you may be subject to AMT tax that we need to navigate together. So it's gonna be even more confusing if I try to explain it than if you if you have ISOs and stock options, call me. We'll sit down and go over your particular situation. So once you have the right to buy your shares, right? You invest in your shares. The question is should you or should you not? When should you strike your shares? When should you buy them? So think with me. You control when you can buy them, and therefore you control your taxable event. So I actually always look for clients to strike or buy their shares when the stock price is lower. That way your tax bill is less, but now you own the shares. So in my previous example, March 1st, 2027, you venture in those 20 shares. You don't have to buy them on that date, right? You can wait. You have 10 years to wait to decide to buy them. Let's say the stock goes from 130 to $90 per share. That might be a good time to say, yeah, I still want to buy them at $80 per share. Now my taxable event is only going to be on that $10 spread. Now my tax bill is going to be less when I bought the shares. Okay. In no other realm of life, your $401K, any other investing in a brokerage account, your taxable event is not when you buy the shares, right? But for stock shop, stock options, it is. So you have to be conscious of when you're buying these shares at what stock price they are. But if you strike, if you buy these shares at a lower price, now you own the shares and your clock starts for that 365-day long-term capital gain bracket. So it usually makes sense to lower your tax bill now. Now you own the shares. It starts your 365 clock. That way, if you do decide to sell them at least a year from now, you're going to get a better rate on that on the stock. Let's say the shares were at $130 per share, but they randomly dip to $60 per share. That's a great time for us to sit down and say, yes, strike your shares. Your tax bill is going to be a lot lower. And even if the stock bounces back to $130, then we'll let's wait to sell them down the road when it goes back up. And that way you have long-term capital gains instead of short-term capital gains. So when you strike or buy your stock options, it needs to be planned on when you do it. It needs to include the other aspects of your life. Did you get a bonus this year? Did you get a bigger bonus than you expected? Is your taxable income going to be higher? Ah, might be a great, might not be a great year to exercise some of your stock options. Right? Did you make a lot of charitable contributions this year and therefore your tax bill will be lower? It might be a great time to exercise your options, just depending on your particular situation. Okay. So when we're planning with clients that have both restricted stock units, stock options, ESPP, we know we can't control the taxable event on RSUs. I went into that last week. Okay, so go back and watch the episode if you haven't. So we have to work around restricted stock. So we can use stock options to our advantage because you and I are picking the taxable event date. And we know the taxable amount based on the stock price and your personal situation and what's going on. So if you have stock options, reach out to us, reach out to a professional to form a game plan around them. Don't just, when you're invested in them, don't just exercise them, strike them, and buy them, and just go on about your life. There's a rhythm to it and there's a rhyme or reason on when and how much, and it really does affect everyone's finances. So the taxes are too complex to just wing it. So don't do that. Last thing I

Cashless Exercise And Getting Help

Speaker 19:50

will say is one thing that creeps up on folks too is keep in mind if you now have 20 shares that you can buy stock at $80 per share, you have to come out of pocket that's $1,600. All right, you're buying 20 shares of a stock for $80 a share, you got to have that money out of pocket. But there is a thing that's called a cashless exercise. So basically what it says is if you and most companies have this as an option, they say, hey, you don't have to actually give us $1,600 to buy these shares on your behalf. We'll just, instead of using cash, it's a cashless exercise. Instead of sending us the cash, we'll just sell a few of your shares, let's say six shares or eight shares, to where we'll just, instead of you coming to the table with cash to buy all 20, we'll just do it for you and we'll send you the net. We'll send you 12 shares or 13 shares, depending on what the math ends up being. And so you're not having to come out of pocket for these shares. Because I have had some clients that their numbers have been bigger, right? And so for them to exercise their stock options, they got to come up with 30 grand. And so they're either dipping into their emergency fund at the bank or they're selling some of their shares in their brokerage account, which can have their own taxes to come up with that cash out of pocket. So a lot of times in those instances, it makes sense. Check the cashless exercise option on the website when you're going through and actually deciding to buy your shares. And here's what the tax ramifications are, and us just walking through it. At the end of the day, we don't just sit down with clients and say, Yeah, you should do this. Okay, go off on your own and do it yourself. We log in together, obviously, with their authority. The client is sitting right here, and we're walking through this together on when you should exercise, how many shares, here's going to be your tax bill. Are you okay with that? Is there a rhyme or reason we should wait a month, four months, 10 months, 20 months? It's very detailed and very personalized. So sit down with an individual, sit down with a professional, I should say, and go through your particular situation because it greatly varies. I will say if you already have a financial advisor and you have stock options or restricted stock units and they're not really talking about it, that's a big miss, right? That's a big deal. Reach out for a competent financial planner that knows about the stuff, knows about the tax ramifications, and sit down and have a game plan with them. Preferably that'd be us. We'd love it to be us. But if your current advisor is not talking about the stuff, that's a big hole, in my opinion, and you in your planning, in your tax planning, and your investment planning, and just overall. So, as always, reach out to us with any questions. If you want to set up a time to talk about your particular stock compensation plan, once again, we can be found. Stansellwealth.com is our website, or you can text us, call us at 469-08-606-2040. Thank you, everyone. Thank you for listening to the Stansell Wealth Podcast. This podcast is for informational and educational purposes only. It is general in nature and may not apply to your specific situation. Please consult with a professional before acting on any information shared in this podcast pertaining to financial, investment, legal, or tax advice. The views expressed by Cody and his guests do not necessarily represent those of Charles Schwab, Victory Financial Group, or any other organization.