How do you cash out stock options

The Tax Consequences of Cashing Out Employee Stock Options.

Employee stock options are grants from your company that give you the right to buy shares for a guaranteed sum called the exercise price. If your company’s stock does well, you can cash in, or exercise, the options, meaning that you use them to buy shares at the exercise price and sell them at a higher market price. The tax consequences depend on Internal Revenue Service rules for the kind of stock options you have.

Nonqualified Options.

Nonqualified stock options are the most common kind of employee stock options. There are no tax consequences when you are granted nonqualified options until you use them by paying your company the exercise price to buy the stock. When you do, the difference between the exercise price and the market price of the stock on the date you exercise them is called your bargain element. Suppose your nonqualified options have an exercise price of $50 per share and the stock is selling for $75 the day you exercise the options. The $25 per share difference is your bargain element. The bargain element is considered part of your compensation along with your salary. The bargain element is added to your other pay on your W-2 and you have to pay income taxes, Social Security tax and Medicare tax on the money. The taxes are due for the year in which you exercise your nonqualified options.

Holding Shares.

After you exercise nonqualified options, you can sell the shares immediately and take the cash. Alternatively, you can hang onto the stock. If you decide to keep it for a while, your investment for tax purposes is called your cost basis and is the market price on the day you exercised the options. When you sell the shares at a future time, you will have a capital gain if the stock has gone up. Suppose the cost basis is $75 per share and you eventually sell the shares at $85. You have a capital gain of $10. If you waited more than a year after the exercise date to sell the shares, it’s a long-term capital gain, and the maximum tax rate on the $10-per-share capital gain is 15 percent. If you waited one year or less, it’s a short-term gain and is taxed at the same rate as ordinary income. If the stock goes down instead of up after you buy the shares, you’ll have a capital loss that you can take as a tax deduction.

Incentive Stock Options.

The second kind of employee stock options you might receive are called incentive stock options. These stock options give you a tax break if you follow special IRS rules. You must wait one year or longer after you are granted incentive stock options to exercise them. Then you must wait at least one more year to sell the shares you purchased with the options. If you meet these requirements, all of your profits, including the bargain element, are taxed as long-term capital gains at a maximum rate of 15 percent. Suppose you exercise incentive stock options and pay an exercise price of $50 per share when the market price is $75, giving you a bargain element of $25 per share. You wait a year and sell the stock when the price has gone up another $10 to $85 per share. Your total profit of $35 per share is taxed as a long-term capital gain.

incentive Stock Option Considerations.

When you exercise incentive stock options, usually no taxes are due. You have a tax liability only when you sell the shares. There are two things to keep in mind. If you are subject to the alternative minimum tax, you’ll have to pay income taxes on the bargain element for the year in which you exercise the options. You’re still entitled to the tax break, but you have to get the money by taking tax credits in future years. Finally, if you exercise incentive stock options in less than a year after you get them or sell the shares less than a year after exercise, you lose the tax break. The IRS treats the options as if they were nonqualified stock options.

References.

About the Author.

Based in Atlanta, Georgia, W D Adkins has been writing professionally since 2008. He writes about business, personal finance and careers. Adkins holds master's degrees in history and sociology from Georgia State University. He became a member of the Society of Professional Journalists in 2009.

Photo Credits.

Digital Vision./Photodisc/Getty Images.

More Articles.

Six employee stock plan mistakes to avoid.

Understanding tax implications and your plan’s rules are among the keys to success.

Stock Plans.

Financial Planning Stock Plans.

Stock options and employee stock purchase programs can be good opportunities to help build potential financial wealth. When managed properly, these benefits can help pay for future college expenses, retirement, or even a vacation home.

But many investors get tripped up, don’t pay attention to critical dates, and haphazardly manage their employee stock option grants. Ultimately, they lose out on the many benefits these stock option plans can potentially provide.

To help ensure that you maximize your stock option benefits, avoid making these six common mistakes:

Mistake #1: Allowing in-the-money stock options to expire.

A stock option grant provides an opportunity to buy a predetermined number of shares of your employer’s company stock at a pre-established price, known as the exercise or strike price. Typically, there is a vesting period ranging from one to four years, and you may have up to 10 years in which to exercise your options to buy the stock.

A stock option is considered “in the money” when it is trading above the original strike price. Say, hypothetically, you have the option to buy 1,000 shares of your employer’s stock at $25 a share. If the stock is currently trading at $50 a share, your options would be $25 a share in the money. If you exercised them and immediately sold the shares at $50, you’d enjoy a pretax profit of $25,000.

You may be tempted to delay exercise as long as possible in the hope that the company’s stock price continues to go up. Delaying will allow you to postpone any tax impact of the exchange, and could increase the gains you realize if you exercise and then sell the shares. But stock option grants are a use-it-or-lose it proposition, which means you must exercise your options before the end of the expiration period. If you don’t act in time, you forfeit your opportunity to exercise the option and buy the stock at the strike price. When this happens, you could end up leaving money on the table, with no recourse.

In some cases, in-the-money options expire worthless because employees simply forget about the deadline. In other cases, employees may plan to exercise on the last possible day, but may get distracted and therefore fail to take necessary action.

“Ask yourself how much extra value you may get by waiting until the last second to exercise your award, and determine if that’s worth the risk of letting the award expire worthless,” says Carl Stegman, senior vice president, Fidelity Stock Plan Services.

Consider these factors when choosing the right time to exercise your stock options:

What are your expectations for the stock price and the stock market in general? If you think the stock has peaked or is likely to fall in the future, consider exercising and selling. If you think it may continue to go up, you may want to exercise and hold the stock, or delay exercising your options. How much time remains until the stock option expires? If you are within 60 days of expiration, it may be time to act, to avoid the risk of letting the options expire worthless. Will you be in the same tax bracket, or a higher or lower one, when you are ready to exercise your options? Taxes have the potential to eat into your returns, so you may want to exercise and sell when you are in the lowest tax bracket possible—though this is just one factor to weigh in your decision.

Tip: Monitor your vesting schedule, keep your contact information updated, and respond to any reminders you receive from your employer or stock plan administrator.

Mistake #2: Failing to understand the tax consequences of ISOs.

There are two kinds of stock option grants: incentive stock options (ISOs) and nonqualified stock options (NSOs). When you receive an ISO grant, there’s no immediate tax effect and you do not have to pay regular income taxes when you exercise your options, although the value of the discount your employer provided and the gain may be subject to alternative minimum tax. However, when you sell shares of the stock, you’ll be required to pay capital gains taxes, assuming you sold the shares at a price higher than your strike price. You must hold your shares at least one year from the date of the exercise and two years from the grant date to qualify for the long-term capital gains rate.

If you sell ISO shares before the required holding period, this is known as a disqualifying disposition. In such a case, the difference between the fair market value of the stock at exercise (the strike price) and the grant price—or the entire amount of gain on the sale, if less—will be taxed as ordinary income, and any remaining gain is taxed as a capital gain. For most people, their ordinary income tax rate is higher than the long-term capital gains tax rate.

While taxes are important, they should not be your sole consideration. You also need to consider the risk that your company’s stock price could decline from its current level. “Be aware of your tax situation, but also understand where you are in the marketplace, because there are also risks to continuing to hold the shares,” says Stegman. “Know which shares are qualified for special tax treatment, what the holding periods are, and transact accordingly.”

Tip: Consult with a tax advisor before you exercise options or sell company stock acquired through an equity compensation plan.

Mistake #3: Not knowing stock plan rules when you leave the company.

When you leave your employer, whether it’s due to a new job, a layoff, or retirement, it’s important not to leave your stock option grants behind. Under most companies’ stock plan rules, you will have no more than 90 days to exercise any existing stock option grants. While you may receive a severance package that lasts six months or more, do not confuse the terms of that package with the expiration date on your stock option grants.

If your company is acquired by a competitor or merges with another company, your vesting could be accelerated. In some cases, you might have the opportunity to immediately exercise your options. However, be sure to check the terms of the merger or acquisition before acting. Find out if the options you own in your current company’s stock will be converted to options to acquire shares in the new company.

Tip: Contact HR for details on your stock option grants before you leave your employer, or if your company merges with another company.

Mistake #4: Concentrating too much of your wealth in company stock.

Earning compensation in the form of company stock or options to buy company stock can be highly lucrative, especially when you work for a company whose stock price has been rising for a long time. At the same time, you should consider whether you have too much of your personal wealth tied to a single stock.

Why? There are two main reasons. From an investment perspective, having your investments highly concentrated in a single stock, rather than in a diversified portfolio, exposes you to excess volatility, based on that one company. Moreover, when that company is also your employer, your financial well-being is already highly concentrated in the fortunes of that company in the form of your job, your paycheck, and your benefits, and possibly even your retirement savings.

History, too, is littered with formerly high-flying companies that later became insolvent. When Enron filed for bankruptcy in 1999, more than $1 billion in employee retirement savings evaporated into thin air. More recently, Lehman Brothers employees shared a similar fate.

Consider, too, that income from your employer pays your nondiscretionary monthly bills and your health insurance. Should your company’s fortunes take a turn for the worse, you could find yourself out of a job, with no health insurance and a depleted nest egg.

“Stock from an equity plan is usually a large component of an employee’s annual compensation, so it’s easy to become overly concentrated in your employer’s stock,” says Stegman. “But you need to take a step back, consider how these benefits fit into your long-term financial objectives, such as college savings, retirement, or a vacation home, and develop a plan to diversify accordingly.”

Tip: Consult with a financial advisor to ensure that your investments are appropriately diversified.

Mistake #5: Ignoring your company’s employee stock purchase plan.

Employee Stock Purchase Plans (ESPPs) allow you to purchase your employer’s stock, usually at a discount from the stock’s current fair market value. These discounts typically range from 5% to 15%. Many plans also offer a “look-back option,” which allows you to buy the stock based on the price on the first or last day of the offering period, whichever is lower. If your company offers a 15% discount and the stock rose 5% during the period, you could buy the stock at a 20% discount, already a healthy pretax gain.

Unfortunately, some employees fail to take advantage of their company's ESPP. If you are not participating, you may want to give your ESPP a second look.

Entry-level employees often opt out of their ESPP, notes Stegman. “But as they become more established in their careers and more financially secure, they should reconsider their ESPP. Depending on the discount your company offers, you could be passing on the opportunity to buy your company's stock at a significant discount.”

Tip: Look at your current savings strategy—including emergency fund and retirement savings—and consider putting some of your savings in an ESPP. You may be able to use future raises to fund the plan without impacting your lifestyle.

Mistake #6: Failing to update your beneficiary information.

Few people like to think about it, but it’s important to keep your beneficiary designations up to date. As with your 401(k) plan or any IRAs you own, your beneficiary designation form allows you to determine who will receive your assets when you die—outside of your will. It’s important to note, however, that if the decedent has made no beneficiary designation, under most plan rules the executor (or administrator) will, in fact, treat equity compensation as an asset of the decedent's estate.

Each time you receive an equity award, your employer will ask you to fill out a beneficiary form. Many grants range in life from three to ten years, during which time many factors can change in your life. For example, if you were single when you received an option grant, you may have named a sibling as the beneficiary. But five years later, you may be married with kids, in which case you would likely want to change your beneficiaries to your spouse and/or children. The same holds true if you were married and got divorced, or divorced and remarried. It’s important to always update your beneficiaries.

Tip: Review your beneficiaries for your equity awards—as well as your retirement accounts—on an annual basis.

Learn more.

Understand the different types of employee compensation plans. Read Viewpoints: "Make the most of company stock."

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A Simple Guide To Making Money With Options.

Over the past few decades, we've seen many advances in how the stock market functions. Today, exchanges and brokerage houses exist almost entirely online, and everyone is competing for microseconds of speed.

As a quick example, let's say IBM is currently trading at $100 per share. Now, let's say an investor purchases one call option contract on IBM with a $100 strike price at a premium of $2.

The call option gives the buyer the right to purchase shares of IBM at $100 per share. In this scenario, the buyer could use the option to purchase those shares at $100, then immediately sell those same shares in the open market for $105. Because of this, the option will sell for $5 on the expiration date.

Using the same analysis as shown above, the call option will now be worth $1 (or $100 per contract). Since the investor spent $200 to purchase the option in the first place, he or she will show a net loss on this trade of $100.

If IBM ends up at or below $100 on the option's expiration date, then the contract will expire "out of the money," meaning it will now be worthless. In this scenario, the option buyer will lose 100% of his or her money (in this case, the full $200 that he or she spent for the contract).

Profit Amplifier Closed Trades.

Aside from a few road bumps, our path to success has been very profitable. In fact, my readers and I have made an average return of 14.5% on our trades so far, and our average holding period stands at just 40 days -- that's good for a 132% annualized return.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of NASDAQ, Inc.

How to Cash in Stock Certificates.

by Jay P. Whickson.

Frequently, when an older person passes, people in charge of the estate find stock certificates in the safety-deposit box or even in a drawer in the home. Few people understand how to sell the certificates, but two options are available. The first is to find the transfer agent, the company handling stock transactions for the certificate holder, and have the stocks changed from certificate form to direct registration or book entry, a record kept at the transfer agent, before selling them. The second is to put them in a brokerage account and then sell them.

Sell Through Transfer Agent.

Find out whom the company uses for the transfer agent. Several different companies offer this service. You can often find this information on the company's investor relations section on its website. Frequently the company's site offers a link to follow directly to its stock section at the transfer agent's site. You'll find a list of transfer agents at the website for Securities Transfer Association, Inc.

Call the transfer agent, and ask for instructions to transfer your stock to direct registration. Normally, you send the agent a letter of instruction, which is simply a letter stating you want to put the certificates into direct registration, along with your certificates. Because replacing the certificates costs 2 percent of the value, insure your package at the post office or shipping company for 2 percent of the total value of the stock.

Wait for confirmation that the transfer agent opened your account and has the stocks directly registered. Once this is complete, you're ready to sell them.

Phone the transfer agent, and request that he sell the stock. The sale takes place at the close of the business day, and you'll receive your check a week to 10 days later.

Deposit With Brokerage Account.

Find a broker to use. Although a live broker makes the process far easier, online brokerages are typically less expensive. The ideal situation is to find a brokerage house that offers face-to-face services and cheaper fees if you trade online.

Open your brokerage account. Make certain the name on the account matches the name on the certificate exactly to prevent additional problems and extra forms. If you're working as an executor or administrator of an estate, you'll be required to fill out additional forms, such as an Affidavit of Domicile, and submit the forms with court papers showing you're the administrator of the estate. You'll need the account number as an additional assurance that the company deposits it correctly. Wait until you have the account opened and receive a number. Some companies suggest you mail in a new account form at the same time you send in the certificates, but you can't put your account number on the certificate. Both methods are valid and just depend on your level of comfort.

Locate the mailing address if you're not presenting the certificates to a broker, and verify what type of documentation you'll need. Although most companies simply request you fill out the back of the certificate and then get a medallion signature guarantee, a stamp guaranteeing your signature to a notary but secured at a bank or financial institution, some may require you to sign a stock/bond power. The brokerage house normally has people that can medallion stamp your signature, but if you hand a broker a certificate to deposit, she uses a stock/bond power form. It has the same purpose as signing the back and allows the company to put the stock into your account.

Take the certificate to a bank or other fiduciary that can signature guarantee the certificate. You'll need to write the name of the brokerage house on the back where you're going to deposit the stock. Locate the spot that says, "Constitute and appoint _______ attorney to transfer." Put the brokerage house name in the blank, and sign your name exactly as it is on the front of the certificate in front of the person giving the medallion signature guarantee. Once he sees you sign, he'll stamp the back. Write your Social Security number and your account number on the front of your certificate before you mail it.

Send the certificate by certified mail if your broker isn't local for extra tracking options. Some people feel more comfortable insuring the certificates for 2 percent of the value, because that's the cost to replace them if they're lost. Once the stock shows up in your account, normally within three to five business days, you can sell it. After the sale, you have to wait three more days for the trade to settle before the company can mail you a check. It then takes a week to 10 days to receive a check, unless you have your brokerage account linked to your checking account. The transfer of funds then takes one to three business days, depending on the financial institutions.

References.

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