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by: Eric R. Heckman, CFP, LUTCF
Who Wants To Be A Millionaire – Without Regis!The raging stock market for the last decade has taught people not to worry about salary but how many stock options they get. Almost every week you hear about another company in the Valley getting bought or going public and all of a sudden everyone in the company is a millionaire. Stock Options are truly the gold rush of the millenium. So, lets party now that we have all this “net worth”, Right? Not so fast. Stock Options are incredibly complex for taxation and you don’t want to give it all to Uncle Sam. For those of us who do not get options, let me explain what they are and then you should try to find a new job at a company that has them. Intel wants to hire you so they give you a nice salary and benefits, but the biggest money is in the options. They give you 1,000 options at $100 that vest 20% over the next 5 years. So, each year you get another 200 options to buy the stock at $100. If Intel is at $150 next year, you can make $50 gain by buying the shares at $100 and then selling them at $150. That is a $10,000 profit and you still have 4 more sets of options coming up. How that $10,000 profit is taxed is complicated! The best options are ISO’s or Incentive Stock Options, but companies are limited on how many of these they can give. ISO’s allow you to buy the shares without having ordinary income taxes due on them right away. However, a lot of people do not realize that often ISO’s can cause you to owe Alternative Minimum Tax or AMT. Depending on the amount of difference between the purchase price ($100 above) and the market value ($150), it may cause you to pay a 26% AMT tax on the difference. Only a tax advisor can figure that out. If so, then your new cost basis is the market value.($150) This is why it is important to exercise ISO’s as soon as allowed so the difference is not as great. If you hold on to the stock for 12 months, then you get the lower Capital Gains tax of 20% max. This can save you thousands. Most people have more NSO’s or Non-qualified Stock Options than ISO. Unlike the ISO’s, these are taxed at ordinary tax rates the second they are exercised regardless of whether you sell the stock. There is not much you can do with these to avoid taxes. If you like the stock and what to keep as many shares as possible, then you should still exercise right away to keep the taxes down. Once the shares are yours, the gain after the purchase can get the lower capital gains tax if held for 12 months. If you work for a company that has not gone public yet, you should exercise the options ASAP since the stock is still low. Then when it goes public, you could sell sooner for less tax. But this is only one problem, the more complicated question is WHEN to sell! There is a large difference between financial planning and tax planning. Financial planning deals with the reality of the economy and markets. Tax planning is based on the whims of Congress. So the best move from a tax standpoint may be to hold your ISO shares for a year but that is a lot of risk on one company. Etoys & iVillage are just a couple of stocks that skyrocketed – up – and then – down. If you held on to these, most of your wealth would disappear. I think the only way to address this problem is to sell a certain amount of shares on a regular basis. This locks in some profits and still allows you to participate in the growth of the stock. Say you have 10,000 shares, then sell a 1,000 each year. Invest the proceeds in diversified mutual funds to protect your gains and to lessen the risk on the one company. Financially, depending on the company, this will often be yield higher results than leaving them in one company. Remember to not spend the money until you actually have it, since in this market, it can come and go. Most importantly, don’t just talk to a financial planner or just a tax advisor, talk to both. Both people are looking at the same thing from very different viewpoints and you need information from both to make a smart decision. Eric R. Heckman provides Financial, Insurance, Investment & Stock Option Planning Executive and Employee Benefits. He can be reached by email at: the@wealthcreator.com, or at 408-297-9800 Fax: 408-297-9899
For more information visit: www.leapsystems.com
Note: The information provided herein is of general nature, and should not be construed as personal investment, financial or legal advice. |
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