Some questions on exercising stock options...

[StageLeft]

I have a fairly small number of options vested with my company. They are currently set at about 1/6 the going rate on the market. It seems to me that it's a no brainer to excercise them, as long as the company's stock never falls below their price (which is unlikely any time soon).

I send a cheque to my company and get a certificate for them. Questions:

1) How long is this certificate good for? Is it the equivalent of the number of shares I buy, and can I keep it in my house if I wanted - maybe for years on end, or do I need to find a brokerage firm to take it and "convert" it into shares that tie to an account?

2) I have no brokerage firm that I deal with. What's the simplest way to take this stock certificate and convert to cash? Are there brokers you can go to for a one time use and just pay whatever commission (how much normally?) and have them take this cert, sell the shares, and hook me up with the money?

Thanks!

 

[amdforever2]

The stock certificate can be held forever in your home.

Of course, if it's destroyed, it'll be a pain to replace it.

The certificate will say how many shares you own, you won't have 100 certificates for 100 shares.

Once you want to cash it out, you can take it to somewhere like Edward Jones for a one time sale, or "deposit" the shares into a brokerage account.

 

[StageLeft]

Originally posted by: amdforever2
The stock certificate can be held forever in your home.

Of course, if it's destroyed, it'll be a pain to replace it.

The certificate will say how many shares you own, you won't have 100 certificates for 100 shares.

Once you want to cash it out, you can take it to somewhere like Edward Jones for a one time sale, or "deposit" the shares into a brokerage account.

Cool! How much does a place like EJ charge for this? It's only going to be worth about $500.

 

[frankie38]

1) How long is this certificate good for? Is it the equivalent of the number of shares I buy, and can I keep it in my house if I wanted - maybe for years on end, or do I need to find a brokerage firm to take it and "convert" it into shares that tie to an account?


>The stock certificate does not expire. However, you may need to mail in the certificate if there is a stock split or merger. You may keep the stock certificate anywhere you like. However, if you should lose you cert then it will cost you money to replace it. So, a safe or bank deposit box are good places to keep it. You may choose to deposit your sharees at a broker. Then your shares will be held in "street name". The broker safeguards your cert, handles any reorganizations and takes care of dividends.

There are more pros and cons to each, I have just highlighted some points.

2) I have no brokerage firm that I deal with. What's the simplest way to take this stock certificate and convert to cash? Are there brokers you can go to for a one time use and just pay whatever commission (how much normally?) and have them take this cert, sell the shares, and hook me up with the money?

The easiest way to get cash might be to exercise your options and sell right away. Read your options prospectus to see if this is possible. Be aware that this method results in taxation of proceeds as ordinary income and is subject to FICA. For better tax treatment, you may choose to hold the certificate for at least a year to obtain Long term capital gains taxation on the proceeds at time of sale.

There are of course many brokers. The choice is dependant on many factors such as price, reliability , cust service, etc. This topic is well covered in the financial media and can be researched easily via google.

Another option is place your shares in a DRIP or the copmany dividend reinvestment plan (if there is one) and sell through that vehicle.


A final recommendation is that depending on the type of options you have and your income/fin situation your exercise may subject you to AMT. please consult your cpa or tax professional.

Congrats and good luck.

 

[AmigaMan]

it probably won't be worth it to exercise it unless you really need the money. I had some options that I did a cashless exercise for when they got vested. Usually brokerages will charge a commision of a couple percent (mine was 5% I think, could be wrong) and you do have significant tax implications.

edit:frankie38 covered it better than I did.

 

[StageLeft]

OK, so there is absolutely no risk or tax implication at all by simply buying this certificate from my company, as long as I keep it or give it to a broker and I don't go ahead and sell them...I think I may do that and just keep it for a while. Thanks!

 

[frankie38]

Originally posted by: Skoorb
OK, so there is absolutely no risk or tax implication at all by simply buying this certificate from my company, as long as I keep it or give it to a broker and I don't go ahead and sell them...I think I may do that and just keep it for a while. Thanks!

There is RISK with exercising options and holding stock. Your options have a period of time for you to exercise. Generally speaking, and depending on your fin/tax sit you want to defer the exercise of options as long as possible.

Risks:

1) You need to pay for these options. that is, if you purchase you need to come up with the cash! gains are treated as ordinary income, this will in all likelihood raise yor tax liability for the year.

2) After purchase, the stock price goes down. you have paid taxes on the gains at time of sale, but at lower price there is no gain or less of a gain.

There are many more risks. The risk you have in holding onto the options is that they expire, or they become worthless.

 

[StageLeft]

Originally posted by: frankie38

Originally posted by: Skoorb
OK, so there is absolutely no risk or tax implication at all by simply buying this certificate from my company, as long as I keep it or give it to a broker and I don't go ahead and sell them...I think I may do that and just keep it for a while. Thanks!

There is RISK with exercising options and holding stock. Your options have a period of time for you to exercise. Generally speaking, and depending on your fin/tax sit you want to defer the exercise of options as long as possible.

Risks:

1) You need to pay for these options. that is, if you purchase you need to come up with the cash! gains are treated as ordinary income, this will in all likelihood raise yor tax liability for the year.

2) After purchase, the stock price goes down. you have paid taxes on the gains at time of sale, but at lower price there is no gain or less of a gain.

There are many more risks. The risk you have in holding onto the options is that they expire, or they become worthless.

These options expire in 2011, but the reason I wanted to buy them now was to ensure that if I left my company I'd still have them. So you're saying that if I knew I'd stay with the company forever, it would make sense to not excercise these (ie. buy the certificate), because I can pay tax on the capital gains. But, if I am not sure I'll stay with the company, then it makes sense to at least buy the certificate, whether I sell it later or not - at least in the case of where the stock price is about 6X what the options are priced at (it's really unlikely the stock will dip below what I'm buying the options at).

Oh, if I understand what you're saying - let's say stock is at $6.00, and options are at $1.00, then I will have to pay taxes on $5 X number of shares excercised... However, after that fact I simply pay taxes on the gains/losses as normal.

So if somebody excercises 1000 options at $1 each they're out $1000. Now, since those shares are now worth $6,000 on the market, they have to pay taxes on the capital gains of $5k. If they are paying 25% taxes, that's $1,250+ the $1000 to get the options excercised, means that the person just paid $2,250 to get their hands on the 1000 shares...

 

[StageLeft]

Oh yeah, if I keep that stock cert in my house for the next 30 years I will have to keep reporting it on taxes, if the company stock goes up, right? Normally a brokerage firm prints out papers and all that, but I'd be responsible for it I presume.

 

[Mill]

Originally posted by: Skoorb
Oh yeah, if I keep that stock cert in my house for the next 30 years I will have to keep reporting it on taxes, if the company stock goes up, right? Normally a brokerage firm prints out papers and all that, but I'd be responsible for it I presume.

Until you sell for a gain you don't have to pay taxes. Unless it somehow differs with options...

 

[StageLeft]

Originally posted by: Mill

Originally posted by: Skoorb
Oh yeah, if I keep that stock cert in my house for the next 30 years I will have to keep reporting it on taxes, if the company stock goes up, right? Normally a brokerage firm prints out papers and all that, but I'd be responsible for it I presume.

Until you sell for a gain you don't have to pay taxes. Unless it somehow differs with options...

But, with normal stock - like you buy some for GPRN, for instance, if it keeps going up every year you have to keep paying taxes on those capital gains each year...

 

[amdforever2]

The only tax related to stock is capital gains tax. You do not incur a capital gain until you sell a security for more than what you bought it at.

You can buy these shares now, hold them until the day you die, and not pay a cent of tax. There are no implications until you sell, and then, only in the year you sell.

 

[Mill]

Originally posted by: Skoorb

Originally posted by: Mill

Originally posted by: Skoorb
Oh yeah, if I keep that stock cert in my house for the next 30 years I will have to keep reporting it on taxes, if the company stock goes up, right? Normally a brokerage firm prints out papers and all that, but I'd be responsible for it I presume.

Until you sell for a gain you don't have to pay taxes. Unless it somehow differs with options...

But, with normal stock - like you buy some for GPRN, for instance, if it keeps going up every year you have to keep paying taxes on those capital gains each year...

Only if you sell for a gain. If you "hold" the stock you pay no taxes until you finally decide to sell. Capital Gains ONLY occurs when you sell. You can have 100 shares of MSFT from 1990 and have not paid a single dime in taxes on it -- minus dividends -- which aren't always taxable anymore.

 

[RayH]

You have 2 ways of excercising your options:

1. You can exercise the options for cash in which case the you are buying the shares at the option price and immediately reselling at the market price. You are taxable on the amount received and the taxes might be automatically taken out before you receive the money.

2. You can exercise the options for stock in which case you pay the option price and get the certificates. You will incur a tax on the difference between the option price and the market price even though you did not actually receive any cash. When you later sell the shares you pay tax on any possible gain between the market price at the time you exercised the options and the price at the time of sale.

You can usually also do a combination of the above with possible minimum limits on the number of options involved for example selling enough shares to cover the purchase of the rest.

You'll want to check the option rules for your company but typically, short of being fired for wrongdoing, you still keep your options after you leave the company with the limitation that you need to exercise them within a certain period after you leave (probably within 6 months). Depending on your company situation you may also want to check the rules on what happens to the options if the company gets taken over.

What you don't want to do is be in a situation where you're paying taxes on the exercise of options for shares that later become worthless if the price drops. During the dotcom days of ovenight millionaires there were some that took the risk of converting all their options to shares without taking any cash to pay the taxes believing the shares would continue to skyrocket. Some of those stocks plunged, and people were left left paying taxes on millions of dollars they never had with no cash to pay it with.

 

[Mill]

Originally posted by: RayH
You have 2 ways of excercising your options:

1. You can exercise the options for cash in which case the you are buying the shares at the option price and immediately reselling at the market price. You are taxable on the amount received and the taxes might be automatically taken out before you receive the money.

2. You can exercise the options for stock in which case you pay the option price and get the certificates. You will incur a tax on the difference between the option price and the market price even though you did not actually receive any cash. When you later sell the shares you pay tax on any possible gain between the market price at the time you exercised the options and the price at the time of sale.

You can usually also do a combination of the above with possible minimum limits on the number of options involved for example selling enough shares to cover the purchase of the rest.

You'll want to check the option rules for your company but typically, short of being fired for wrongdoing, you still keep your options after you leave the company with the limitation that you need to exercise them within a certain period after you leave (probably within 6 months). Depending on your company situation you may also want to check the rules on what happens to the options if the company gets taken over.

What you don't want to do is be in a situation where you're paying taxes on the exercise of options for shares that later become worthless if the price drops. During the dotcom days of ovenight millionaires there were some that took the risk of converting all their options to shares without taking any cash to pay the taxes believing the shares would continue to skyrocket. Some of those stocks plunged, and people were left left paying taxes on millions of dollars they never had with no cash to pay it with.

So when you exercise the option for stock, you are in effect selling it and have to pay taxes on any gains?

 

[RayH]

I think in the case of exercising for stock the government treats it like income instead of capital gains.

 

[Mill]

Skoorbie

IF YOU PLAY your cards right with Incentive Stock Options, or ISOs, you could protect a significant amount of your profit from the IRS, thanks to two important tax advantages. First of all, you don't have to pay taxes immediately when you exercise ISOs ? as long as you don't sell the stock you receive. Second, while you will have to pay taxes when you sell, you can qualify for the 15% maximum rate on long-term capital gains.

As we discuss in the other piece, with nonqualified options, you must pay income tax on the spread between the exercise price and the market price in the year you exercise. Then, when you sell the stock, you pay a separate tax on the spread between the market price at exercise and the price you eventually sell it for.

With ISOs, all the taxes are paid when you sell the stock and it's all capital gains. The catch? This deal applies only if you sell the ISO shares more than two years after the option-grant date (the date you received the option) and more than one year after you actually bought the shares by exercising your ISO. (If you sell sooner than that on either front you have what the IRS calls a "disqualifying disposition" ? more on that in a moment.)

Here's an example. On June 30, 2002, you receive an ISO giving you the right to purchase 100 shares of employer stock for $10 a share. You exercise on June 2, 2003, when the market price is $16. Your per-share basis is $10 (that's the exercise price). You then sell on Aug. 2, 2004, for $25 a share. The sale date is more than two years after the June 30, 2002, grant date and more than 12 months after the June 2, 2003, exercise date. Therefore, your entire $1,500 profit is treated as a long-term capital gain qualifying for the 15% maximum federal rate.

Now, what if you meet the above rules but sell your ISO shares at a price that's either below the market value on the exercise date or (even worse) below the exercise price? In this case, your basis in the shares is the exercise price, so when the sale price exceeds that number, you have a gain that qualifies for the 15% maximum rate. If your sale price is below the exercise price, you've got a long-term capital loss. Sorry about that.

Disqualifying Dispositions
If you don't follow the holding rules, the favorable tax treatment of ISOs disappears.

If you make what's called a "disqualifying disposition" by selling less than two years after the grant date or less than one year after the exercise date, some or all of your gain will now be taxed as ordinary income rather than at the lower capital-gains rate. The tax rate on the spread from the exercise price to the price at which you sell the stock will depend on your holding period (which begins on the day after the exercise date).

For example, say you make a disqualifying disposition by selling less than two years after the grant date, but you owned the shares for more than a year after the exercise date. In that case, you'd owe income tax on the spread from the exercise price to the market price, and then capital gains on the gain after you exercised.