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- How Do Stock Options Work? A Guide for Employees - Smartasset?
As with stock options, restricted stock grants are subject to a vesting schedule, typically tied to either passage of time or achievement of a specific goal. Keep in mind that the vesting of restricted stock grants is a taxable event. This means that taxes will have to be paid based on the value of the shares at the time they vest. Your employer decides which tax payment options are available to you — these may include paying cash, selling some of the vested shares, or having your employer withhold some of the shares.
This is a fairly complex area related to the current tax code. Therefore, you should consult your tax advisor to better understand your personal situation. The difference primarily lies in how the two are taxed. And resulting gain or loss may qualify as long-term capital gains or loss if held more than a year. Non-qualified options, on the other hand, can result in ordinary taxable income when exercised. Tax is based on the difference between the exercise price and fair market value at the time of exercise.
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Subsequent sales may result in capital gain or loss — short or long term, depending on duration held. Tax treatment for each transaction will depend on the type of stock option you own and other variables related to your individual situation. For specific advice, you should consult a tax advisor or accountant.
When it comes to employee stock options and shares, the decision to hold or sell boils down to the basics of long term investing.
For the Last Time: Stock Options Are an Expense
Ask yourself: how much risk am I willing to take? Is my portfolio well-diversified based on my current needs and goals? How does this investment fit in with my overall financial strategy? Your decision to exercise, hold or sell some or all of your shares should consider these questions. Many people choose what is referred to as a same-day sale or cashless exercise in which you exercise your vested options and simultaneously sell the shares.
Employee Stock Option (ESO) Definition
This provides immediate access to your actual proceeds profit, less associated commissions, fees and taxes. Many firms make tools available that help plan a participant's model in advance and estimate proceeds from a particular transaction.
In all cases, you should consult a tax advisor or financial planner for advice on your personal financial situation. It is great to have confidence in your employer, but you should consider your total portfolio and overall diversification strategy when thinking about any investment — including one in company stock.
There is no single answer to this. If a company remains private, there may be limited opportunities to sell vested or unrestricted shares, but it will vary by the plan and the company.
What does exercising stock options mean?
You can use savings, rollover proceeds from another stock sale, or borrow from a brokerage account and pay it back immediately. Timing is important, however. If the stock price is trading lower than the grant price, the options are said to be underwater. Exercising options is useless if the employee can buy shares of the company stock for less on the open market. Most employees get NSOs, which are priced at a discount and taxed at ordinary income tax rates. A tax hit occurs once the options are exercised, so you pay either income tax or capital gains tax depending on whether your option is qualified, based on the grant price.
Once you exercise the options, you can sell the shares after a short waiting period, or hold onto the shares and wait for the stock to increase further before selling. Some investors hedge their bets by doing a bit of each. Once reserved only for the executive team, stock options became a popular form of compensation during the tech boom in the late s. Back then, there were many tales of stock option success, and certain types of employees were looking for a sense of ownership in their workplace that went beyond the paycheck.
By , so many options were underwater that they lost some of their appeal among the corporate masses. But in the world of start-ups, enough people got very wealthy from stock options that they remain a great tool for attracting early-stage talent. There are a variety of reasons employers want to offer stock options.
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Vesting programs can help build longer-term loyalty among employees. The sense of shared ownership can foster a strong corporate culture.
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Employees literally help to grow the company not just as staff, but as shareholders. For employees, stock options can result in tremendous wealth, particularly if you join the company at an early or growing stage. On the flip side, those are the companies that are also likely to go under with only worthless stock options left behind. Stock options have expiration dates and will be worthless if held too long.