What seems like daily, we help clients make important decisions regarding their company stock plans. If done correctly, the positive impact to your long-term goals is substantial. However, it takes careful planning to ensure you’re maximizing the benefit you receive while being cautious of the potential tax consequences. Most don’t understand how these plans work and they make poor decisions that minimize the benefit and maximize the taxes.
Each of the common plans offer a tremendous opportunity to create additional wealth that, if properly utilized, can speed you to your life/wealth goals. We find that most people make the sale decision on these plans based on wanting to receive the cash immediately, but that often times results in higher taxes or missed opportunity. Working with our team of Personal CFOs, our clients are given detailed analysis on the stock’s performance outlook, the tax implications of each potential decision, options for how to recognize the value of the shares, all within the context of their goals. Approaching these decisions with such care, ensures you get the most out of the opportunity these plans present. If you, or coworkers are facing these types of decisions, we are here, as true experts, to help empower you to make the right decision for your situation.
Before we dive into strategy, it’s important to understand the different types of company stock that might be available in the overall company stock plan. The stock plan jargon is often difficult to understand so we’ll describe the common terms used, in a commonsense way.
Restricted Stock Units, or more commonly known as RSUs, are shares of the company that are given, known as granted, to key employees as a form of compensation. Often times, these shares vest, or become sellable, over a period of time. A common vesting schedule would be ¼ of the shares become sellable on the 1-year anniversary of the grant, and then will continue to vest each year for the next 3.
Stock Options allow an employee to purchase a set number of shares at a set price. Again, these are often granted to the employee as a form of compensation and they usually come with a vesting schedule, dictating when you can exercise, or purchase, the shares at the strike price (set price).
Employee Stock Purchase Plan, or commonly referred to as an ESPP, is a plan sponsored by the company that allows employees to withhold a portion of their net pay to purchase shares of the company, often at a discount. The purchase period is usually 3 to 6 months, with the withheld dollars accruing each pay period and the shares being purchased on the final day of the period. Once purchased, the shares are deposited into your account and you are free to trade them as you see fit.
Now that we have an understanding of what the plan types are, we’ll dive into how they operate and the tax considerations. Your Crown advisor fully understands the details so if you stop reading now and simply reach out to us, that works too!
Restricted Stock Units – these shares do not hold useable, or taxable value until they vest and become sellable. On the day your shares vest, the number of shares times the stock price equals the vested value and the amount of taxable income that you will report. Because these shares were given to you, and you now recognize the value, you are required to pay ordinary income taxes on the entire value at vest. Before the shares vest, you are often required to make a tax election. One option is to receive the full number of shares and pay the tax outside of the stock plan. The more common choice is to have the plan administrator automatically sell a portion of your shares and submit the cash to the IRS and, in most states, your state Department of Revenue as income tax withholding. Whether you elected to keep all the shares, or sell some for taxes, the remaining shares are then deposited in your account and you are free to trade them as you wish. If you were to sell the remaining shares as soon as you received them, there would most likely be no additional tax due and the net proceeds would be yours to utilize as you see fit. If you continue to hold the shares, there is an adjusted cost basis based on the grant price, vest price and taxes paid. If the value increases and you sell them, you’ll report an additional capital gain. If the value decreases and you sell them, you’ll report a capital loss. If the shares were held at least a year from the vest date, the gain/loss would be long-term and taxed at preferential tax rates, but if held less than a year, it would be short-term and taxed at ordinary income rates.
Stock Options – like RSUs, these shares do not hold useable value until they vest, and they don’t represent taxable value until they are exercised. It’s easier to use an example for stock options. Let’s assume you were granted 1,000 shares of stock ABC at a strike (purchase) price of $10 per share and that the shares are on a 4-year vest schedule. One year after the grant date, 250 shares are now vested and you have the option to buy those shares at the price of $10 per share. If ABC stock is worth $8, there is no current value to the options as you would have to pay more than the shares are worth so you would choose instead to hold the options in the hopes the share price gets over $10 in the future. If ABC stock is worth $20, your options are “in the money” and represent real value that you can capitalize on. You now have a choice to make. You can purchase the 250 shares at $10 each for a total price of $2,500. You would fund your account with the cash to make the purchase. You would elect this option if you wished to hold the shares for longer-term investment purposes and/or to move the gain into long-term status after one year. The second option would be a cashless one, where the shares are bought and immediately sold by the plan’s custodian. You would receive the difference between the purchase price and the sale price. Using the previous example, 250 shares would be bought for $10, sold for $20, and you would receive the $2,500 cash proceeds. The full amount of proceeds would be considered short-term capital gain and would be taxed at ordinary income rates.
Employee Stock Purchase Plan – as previously described, you are funding the purchase of these shares by withholding a portion of your after-tax pay. As an example, let’s say you elected to contribute $500 per month to this plan and the purchase period was 6 months. At the end of the purchase period, there would be $3,000 in your ESPP account and that cash would be used to purchase $3,000 worth of company stock. Almost all plans have a provision that allows you to purchase the shares at the lower of either the first or last day of the purchase period. So, if the stock has increased in value over the purchase period, you would purchase the shares at the beginning price. The difference in the purchase price and the current value would represent an unrealized gain. If the stock has decreased in value over the purchase period, you would purchase the shares at the ending price, and would therefore have no increase in value or unrealized gain. You now own the shares and can hold them or sell them, keeping in mind the capital gain tax rules. The big kicker on many of these plans are the discounts the company offers on the purchase price. Many of our clients work for companies that offer a discount of 15% off the purchase price, and this would be after the first or last day price was chosen. In this situation, the instant gain can be very large if the stock increased in value over the purchase period. If it decreased, you still get the guaranteed 15% return on the day the purchase is made.
If you have questions or know of others this can help, please don’t hesitate to reach out to us or forward their way. Unfortunately, this is an area of advice many advisors in our industry simply say, "you'll need to ask your CPA about that." That route can result in conflicting advice and is not the way we do things at Crown!