Today on Market Vizion, I want to talk about executive stock options. If you're an executive in the pharmaceutical industry or within many other industries for that matter, you receive a portion of your compensation through stock options.
Often times, there are two main kinds of stock options with different conditions, benefits, and limitations – specifically when it comes to taxes. It leaves you with the sometimes complicated decision of selecting the best one for your specific household and financial goals.
Here, we're going to tackle the main kinds of stock options, how they work, and what they mean for you.
Non-Qualified Stock Options
The first one we'll talk about is the most common, and that is non-qualified stock options. Non-qualified stock options act just like a traditional option where you have a strike price.
So let's say you're given the option to buy a stock at $10 a share. Right now, the company's stock is at $30 a share. So, when you exercise your stock option at $10, you're netting the $20 profit in your pocket.
Now, here's the big challenge from a tax perspective: that $20 is now able to be taxed under your income tax.
There are very few strategy options that can be applied to change that. You can't change it into a capital gain. You can't defer it. You can't stretch it out over time. There are a few things from a strategic perspective that can be done to help manage the cost or the tax liability associated with the exercise of non-qualified stock options.
In terms of the exercise and the value associated with the stock option itself, it's all income tax.
Incentive Stock Options
The second kind of option is where there's a huge planning opportunity – and some challenges. These are incentive stock options often called ISO's.
Like I mentioned, if you have ISO's, you have a unique strategy opportunity around those options because you have the right not to just cashlessly exercise them like you would do with a non-qualified stock option. You actually have the right to exercise the option and buy the stock.
Now the challenge is if you have a thousand options and the strike price is $10 a share, that means you need to put up $10,000 in cash to exercise those options.
There is a reason to do this because, strategically, if you exercise the option and buy the stock, hold it long enough for it to count as long-term capital gains, then you can turn the income tax liability into a long-term capital gains tax liability. Historically, capital gains, especially the long-term capital gains, have been taxed more favorably than the higher income tax brackets.
Converting Income Tax Liability into Long-Term Capital Gains Tax Liability
The challenge then is if you have, let's just say, 100,000 ISO stock options and the strike price is $10 a share... Yeah, you have to come up with a million dollars to buy that stock. For many of our clients, that's challenging.
At Vizionary Wealth, we work with clients to manage the stock option equity as a part of their overall portfolio. This means a lot of working to plan, often, years in advance for how we're going to find the capital to strategically convert that income tax liability into a long-term capital gain tax liability.
There's strategic planning opportunities when it comes to incentive stock options that simply don't exist in the non-qualified stock option world. It's very important to understand each of them.
Getting the Perspective that's Best For You
Here at Vizionary Wealth Management, we're always here with perspective for the decisions ahead. I've spent the last 25 years of my career specializing in executive financial planning - specifically in pharmaceutical environments.
If you are looking for a new partner to help you navigate your increasingly complicated financial world as an executive, let's start the conversation. Reach out and I'd be happy to help answer any questions you have about your financial plan.