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Lane
Lane, JD, CFP, MBA, CRPS
Category: Finance
Satisfied Customers: 11546
Experience:  Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
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What is the most tax favorable and secure way to receive

Customer Question

What is the most tax favorable and secure way to receive stocks in a company through vesting and why. Is there a better way than RSU.
Submitted: 11 months ago.
Category: Finance
Expert:  Lane replied 11 months ago.

I've filed an underpriced question report here. this is a HIGHLY complicated area.

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Restricted stock is straightforward.

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ISO's (Inventive Stock Options) and NSO's (non-qualified stock options) are completely different and can be taxed n VARIOUS ways, depending on timing of the exercise, some come with ATM (Alternative Minimum tax issues), and the list goes on.

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I typically charge (and this is very competitive) $1000 for an analysis of a taxpayers various strategies for exercising options (I use specialized software, that takes into account the multitude of other issues - financial needs, cash flow, client's filing status and brackets, AMT exposure, cost of waiting, - etc., etc.)

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Expert:  Lane replied 11 months ago.

What I can do is paste in an overview written by Gwenaelle Romain:

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There are two broad classifications of stock options issued; Non Qualified Options (NSO) and Incentive Stock Options (ISO).

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Non-qualified stock options differ from incentive stock options in two ways. First, NSOs are offered to non-executive employees and outside directors or consultants. By contrast, ISOs are strictly reserved for employees (more specifically, executives) of the company. Secondly, nonqualified options do not receive special federal tax treatment, while incentive stock options are given favorable tax treatment because they meet specific statutory rules described by the Internal Revenue Code (more on this favorable tax treatment is provided below).

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NSO and ISO plans share a common trait: they can feel complex! Transactions within these plans must follow specific terms set forth by the employer agreement and the Internal Revenue Code.

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Grant Date, Expiration, Vesting and Exercise

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To begin, employees are typically not granted full ownership of the options on the initiation date of the contract (also know as the grant date). They must comply with a specific schedule known as the vesting schedule when exercising their options. The vesting schedule begins on the day the options are granted and lists the dates that an employee is able to exercise a specific number of shares. For example, an employer may grant 1,000 shares on the grant date, but a year from that date, 200 shares will vest (the employee is given the right to exercise 200 of the 1,000 shares initially granted). The year after, another 200 shares are vested, and so on. The vesting schedule is followed by an EXPIRATION DATE. On this date, the employer no longer reserves the right for its employee to purchase company stock under the terms of the agreement.

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An employee stock option is granted at a specific price, known as the EXERCISE PRICE. It is the price per share that an employee must pay to exercise his or her options. The exercise price is important because it is used to determine the gain (called the bargain element) and the tax payable on the contract. The bargain element is calculated by subtracting the exercise price from the market price of the company stock on the date the option is exercised.

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Taxing Employee Stock Options
The Internal Revenue Code also has a set of rules that an owner must obey to avoid paying hefty taxes on his or her contracts. The taxation of stock option contracts depends on the type of option owned.

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For non-qualified stock options (NSO):

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  • The grant is not a taxable event.
  • Taxation begins at the time of exercise. The bargain element of a non-qualified stock option is considered "compensation" and is taxed at ordinary income tax rates. For example, if an employee is granted 100 shares of Stock A at an exercise price of $25, the market value of the stock at the time of exercise is $50. The bargain element on the contract is ($50 - $25) x 100=$2,500. Note that we are assuming that these shares are 100% vested.
  • The sale of the security triggers another taxable event: If the employee decides to sell the shares immediately (or less than a year from exercise), the transaction will be reported as a short-term capital gain (or loss) and will be subject to tax at ordinary income tax rates. If the employee decides to sell the shares a year after the exercise, the sale will be reported aslong term capital gain (or loss) and the tax will be reduced.

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Incentive stock options (ISO) receive special tax treatment:

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  • The grant is not a taxable transaction.
  • No taxable events are reported at exercise; however, the bargain element of an incentive stock option may trigger alternative minimum tax (AMT).
  • The first taxable event occurs at the sale. If the shares are sold immediately after they are exercised, the bargain element is treated as ordinary income
  • The gain on the contract will be treated as a long-term capital gain if the following rule is honored: the stocks have to be held for 12 months after exercise and should not be sold until two years after the grant date. For example, suppose that Stock A is granted on January 1, 2007 (100% vested). The executive exercises the options on June 1, 2008. Should he or she wish to report the gain on the contract as a long-term capital gain, the stock cannot be sold before June 1, 2009.

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Other Considerations

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Although the timing of a stock optyions strategy is important, there are other considerations to be made. Another key aspect of stock option planning is the effect that these instruments will have on overall asset allocation. For any investment plan to be successful, the assets have to be properly diversified. An employee should be wary of concentrated positions on any company's stock. Most financial advisors suggest that company stock should represent 20% (at most) of the overall investment plan. While you may feel comfortable investing a larger percentage of your portfolio in your own company, it's simply safer to diversify. Consult a financial and/or tax specialist to determine the best execution plan for your portfolio.

Customer: replied 11 months ago.
Thanks.. This helps. please email me your contact information***@******.***
Expert:  Lane replied 11 months ago.

Will do ... I'll add one more piece to this ... You might want to look up "83(b) election."

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This is a way to have the taxation for certain contracts BE taxed in the year received ... (rather than being taxed as they vest - when very possibly worth much more)

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If you have stock options, sometimes, depending on the type of option, you do not need to file an 83(b) Election Form, unless you exercised the option early.
• If you purchased/received founder’s stock and there are no restrictions, such as vesting, you do not need to file an 83(b) Election Form.
• If you purchased/received restricted stock in a growing startup, you should probably ( 99% of the time) file an 83(b) Election Form.

Also very important ... the election needs to be mailed Mail it to the IRS address below within 30 days after the stock grant (there is no relief if you file late). I would mail Certified Return Receipt Requested to prove timely delivery. Then file a copy of thet WITH your tax return for the tax year of the grant

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Many people mess up by only filing the election with the tax return

Expert:  Lane replied 11 months ago.

If this HAS helped, … I'd appreciate a positive rating (using the faces or stars on your screen, and then clicking “submit")

JustAnswer will not credit me for the work unless you do.

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Thank you!

Lane

I have a law degree, (Juris Doctorate), with concentration in Tax Law, Estate law & Corporate law, an MBA, with specialization in financial accounting & tax, a BBA, and CFP & CRPS designations, as well - I’ve been providing financial, Social Security/Medicare, estate, corporate, non-profit, and tax advice, since 1986.