Best Way to Handle Non-Qualified Stock Options that Vest Annually?

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills.
Post Reply
Topic Author
Zagnificent
Posts: 75
Joined: Wed Oct 06, 2021 10:12 am

Best Way to Handle Non-Qualified Stock Options that Vest Annually?

Post by Zagnificent »

First and foremost, thank you all in advance for the sage advice. I work for a small but rapidly growing company with great upside. In the past 18 months our company both went public and was added to the S&P 600. As a fairly early hire at the company, I was given ~4,900 NQ options at an exercise price of $8.22. For the sake of simplicity, let's say the current stock price is $40.22. The vesting schedule has 20% annually, and I'm fully vested by April 2024.

I'm having a tough time understanding exactly what is the most efficient way of acquiring the value of these options while minimizing my tax burden in the process. With a combined household income approaching $300k, exercising these options and selling immediately would be quite the tax bill at EOY, as basically all the proceeds would be taxed at my marginal rate (in addition to the $32 delta being taxed as income).

In order to reduce my overall taxation and optimize future growth, should I be exercising and holding these options annually once they vest, assuming the price of the stock will continue on a positive trajectory? And then hold for at least a year before selling to ensure I'm taxed on the proceeds of the sale at a capital gains rate of 15%? Or, given this forum's appreciation for index funds, should I exercise and sell immediately, setting aside profits for the tax bill while reinvesting the difference in a more diversified fund like VTSAX?

Again, thank you for all the feedback. I'm sure many of you have much more experience in this area than I do.
Last edited by Zagnificent on Sat Oct 23, 2021 4:09 pm, edited 1 time in total.
crefwatch
Posts: 2493
Joined: Sun Apr 15, 2007 1:07 pm
Location: New Jersey, USA
Contact:

Post by crefwatch »

(Do perform a search, as this topic has come up before ... )

You did not say if the options are ISO or NQ. Very important distinction.

In general, the taxes are your problem. That's why executives (I don't necessarily mean of your company ...) with staggering amounts of options have developed phony derivatives of derivatives products that allowed (or used to, at least) trading the options to investors without selling them. (!) Some more ethical corporations restricted those practices. If the options are NQ,you will have not only income taxes but other payroll taxes (like Social Security) to pay.

You don't say if you have already thought about whether you wish to have substantial investments in your company's equity while your wages and benefits are also coming from that company. A lot of people at places like Enron and We Work found out the hard way that that was not such a good deal.
Topic Author
Zagnificent
Posts: 75
Joined: Wed Oct 06, 2021 10:12 am

Re:

Post by Zagnificent »

crefwatch wrote: Sat Oct 23, 2021 3:20 pm (Do perform a search, as this topic has come up before ... )

You did not say if the options are ISO or NQ. Very important distinction.

In general, the taxes are your problem. That's why executives (I don't necessarily mean of your company ...) with staggering amounts of options have developed phony derivatives of derivatives products that allowed (or used to, at least) trading the options to investors without selling them. (!) Some more ethical corporations restricted those practices. If the options are NQ,you will have not only income taxes but other payroll taxes (like Social Security) to pay.

You don't say if you have already thought about whether you wish to have substantial investments in your company's equity while your wages and benefits are also coming from that company. A lot of people at places like Enron and We Work found out the hard way that that was not such a good deal.
I've tried some searching and not found much that is applicable (perhaps I'm not filtering my search appropriately).
They're NQ options. So yes, there would be a heavy tax burden.
I'm bullish on the company, and I honestly think the greatest likelihood is that the company is sold to a larger player in the space in the next several years. Still, I don't like having that much tied-up in a single stock, regardless of my belief in the company. I'm in no way dependent upon this money, though, and I have large investments in more diversified Vanguard funds as well as through retirement accounts.
D-Dog
Posts: 120
Joined: Sat Dec 01, 2007 11:44 pm

Re: Best Way to Handle Non-Qualified Stock Options that Vest Annually?

Post by D-Dog »

Zagnificent wrote: Sat Oct 23, 2021 3:13 pm First and foremost, thank you all in advance for the sage advice. I work for a small but rapidly growing company with great upside. In the past 18 months our company both went public and was added to the S&P 600. As a fairly early hire at the company, I was given ~4,900 NQ options at an exercise price of $8.22. For the sake of simplicity, let's say the current stock price is $40.22. The vesting schedule has 20% annually, and I'm fully vested by April 2024.

I'm having a tough time understanding exactly what is the most efficient way of acquiring the value of these options while minimizing my tax burden in the process. With a combined household income approaching $300k, exercising these options and selling immediately would be quite the tax bill at EOY, as basically all the proceeds would be taxed at my marginal rate (in addition to the $32 delta being taxed as income).

In order to reduce my overall taxation and optimize future growth, should I be exercising and holding these options annually once they vest, assuming the price of the stock will continue on a positive trajectory? And then hold for at least a year before selling to ensure I'm taxed on the proceeds of the sale at a capital gains rate of 15%? Or, given this forum's appreciation for index funds, should I exercise and sell immediately, setting aside profits for the tax bill while reinvesting the difference in a more diversified fund like VTSAX?

Again, thank you for all the feedback. I'm sure many of you have much more experience in this area than I do.
This is my understanding, but double check this. If you exercise the options and take the shares, I believe that is still a taxable event and the gain will be taxed as ordinary income. Any further appreciation after the exercise will be a capital gain. If you had that much cash, would you choose to buy the shares? If not, then take the cash. You might want to ask yourself which you would regret more, waiting to exercise and having the options become worthless, or exercising the options and having the value increase. I have generally exercised options as they vest and take the cash.
Topic Author
Zagnificent
Posts: 75
Joined: Wed Oct 06, 2021 10:12 am

Re: Best Way to Handle Non-Qualified Stock Options that Vest Annually?

Post by Zagnificent »

D-Dog wrote: Sat Oct 23, 2021 6:44 pm
Zagnificent wrote: Sat Oct 23, 2021 3:13 pm First and foremost, thank you all in advance for the sage advice. I work for a small but rapidly growing company with great upside. In the past 18 months our company both went public and was added to the S&P 600. As a fairly early hire at the company, I was given ~4,900 NQ options at an exercise price of $8.22. For the sake of simplicity, let's say the current stock price is $40.22. The vesting schedule has 20% annually, and I'm fully vested by April 2024.

I'm having a tough time understanding exactly what is the most efficient way of acquiring the value of these options while minimizing my tax burden in the process. With a combined household income approaching $300k, exercising these options and selling immediately would be quite the tax bill at EOY, as basically all the proceeds would be taxed at my marginal rate (in addition to the $32 delta being taxed as income).

In order to reduce my overall taxation and optimize future growth, should I be exercising and holding these options annually once they vest, assuming the price of the stock will continue on a positive trajectory? And then hold for at least a year before selling to ensure I'm taxed on the proceeds of the sale at a capital gains rate of 15%? Or, given this forum's appreciation for index funds, should I exercise and sell immediately, setting aside profits for the tax bill while reinvesting the difference in a more diversified fund like VTSAX?

Again, thank you for all the feedback. I'm sure many of you have much more experience in this area than I do.
This is my understanding, but double check this. If you exercise the options and take the shares, I believe that is still a taxable event and the gain will be taxed as ordinary income. Any further appreciation after the exercise will be a capital gain. If you had that much cash, would you choose to buy the shares? If not, then take the cash. You might want to ask yourself which you would regret more, waiting to exercise and having the options become worthless, or exercising the options and having the value increase. I have generally exercised options as they vest and take the cash.
Thank you very much. This is actually the most simple and clear response that I’ve found on the topic. It only makes sense to buy and hold the shares if I seriously believe the stock will be going up, and even then, there’s no effective difference between exercising and cashing out only to rebuy, vs exercising and holding.
User avatar
Cheese
Posts: 73
Joined: Tue Jan 08, 2013 8:08 pm

Re: Best Way to Handle Non-Qualified Stock Options that Vest Annually?

Post by Cheese »

Correct NQ options create a taxable event upon exercise. ISO allow for capital gain if you exercise and meet holding requirements (2 years from grant, 1 year from vest).

On NQ you will pay the tax when you exercise (typically people do a cashless or net exercise and have taxes withheld). I’ve seen some try to stretch this out across years to minimize taxes but then you are also playing the “save tax/stock price volatility” game.

It becomes psychological - maybe you could devise a plan where you exercise a certain % each year and let the rest ride? You likely won’t time it perfectly in any scenario but writing down a plan can help immensely.

Good luck - you’re in a great position!
knowledge
Posts: 486
Joined: Wed Mar 02, 2011 4:44 pm

Re: Best Way to Handle Non-Qualified Stock Options that Vest Annually?

Post by knowledge »

It seems like you have a handle on the tax implications. I would worry less about optimizing taxes, and look to optimize overall value. That's difficult to swallow since that means giving enough time for the time value of the option to be realized, and is certainly not guaranteed.

Since these options are in the money, some sort of hybrid approach where you take a few off the table makes sense, while holding on much as you can for the potential upside - to be clear, this isn't exercise and hold, this is just don't exercise until closer to expiration.
Firemenot
Posts: 1496
Joined: Wed Apr 01, 2020 8:48 pm

Re: Best Way to Handle Non-Qualified Stock Options that Vest Annually?

Post by Firemenot »

It’s several years later now. What did you do? Anything you learned that you’d be willing to share?
Post Reply