Planning for Executives Flashcards
What is the annual limit for ISOs?
Annual $100,000 limit
Who can receive ISOs?
Can only be given to employees
Which type of employee stock option is transferable at death?
NSOs
How do you get LTCG treatment on ISOs?
sold more than 1 year after exercise
And if sold more than 2 years after grant
Disqualifying Disposition
If you sell, transfer, gift, or short the stock too soon, you lose the tax benefits of ISOs that occur with a qualifying disposition.
Not adhering to the holding period requirement
Potential taxation includes ordinary income tax treatment a compensation and possible capital gains tax on the transaction. There are situations in which this may be a preferred strategy (e.g., based on expectation of stock price)
Who can receive NSO?
Employees,
Directors,
Consultants
What is the difference between the triggering event for an NSO vs ISO
Triggering Event for NSO: Exercise (Ordinary Income)
Triggering Event for ISO: Stock Sale ( LTCG potential)
What are 4 tax minimization strategies for options?
- AMT Planning
- Tandem Exercise
- Option Gifting
- Grantor CLT
What are 3 Wealth Accumulation Strategies for Employee Options?
- Stock Swap
- Early Exercise
- Exercise Early / Exercise Late
What is a Diversification strategy ?
• Exercise and Sell
What is a cashless exercise?
– Simultaneous option exercise and stock sale
– Used anytime after vesting and before expiration
When is Exercise and Hold Applicable?
– Prior to expiration – To capture dividends – Recognize income in a specific year – To produce LTCG on future appreciation – To meet company requirements
What is pyramiding?
Plan specific provision - must specifically allow
Pay cash to exercise the first option, and then a small number of previously owned shares is surrendered to the company to pay a portion of the exercise price, for which a slightly larger number of option shares may be purchased.
These are then immediately swapped back to the company to pay additional amounts of the exercise price, and so on until the remainder of the options have been exercised. In the end you have a number of shares equal in value to the option “spread”
With the advent of broker-assisted “cashless exercise/same-day sale” programs, pyramiding has fallen out of favor.
Who is responsible for income tax on spread at exercise of a gifted NSO?
Donor
What are AMT Planning strategies on ISO Exercise
Exercise ISOs in first quarter of Year 1
Triggers potential AMT due April 15 of Year 2
Hold stock 1 year to meet ISO requirements
Sell stock before April 15 to pay tax
Downside risk is stock price declines in year
Assuming all requirements are met, how is the gain on an ISO sale calculated?
Difference between the exercise price and FMV at exercise is the bargain element - No Tax due. AMT preference item.
Exercise price = basis.
Sale proceeds - Basis = LTCG
is there a tax when an NSO is exercised?
Yes, ordinary income on the bargain element
When an NSO is later sold, what is the tax
Proceeds from sale - Basis = gain
Basis = FMV at exercise
Holding period rules for capital gains treatment applies
When must an Section 83(b) Election election be made?
Must be elected within 30 days of grant
What is the 83(b) election?
IRS recognizes income and levy income taxes of shares when granted, rather than later upon vesting.
If you’re able to exercise your stock options early (prior to vesting), you could elect to do so and file an 83(b) election within 30 days of exercise. This way, you can potentially minimize your future tax liability if the share price of your company happens to take off.
What is a Section 457 Deferred Compensation Plans
They are non-qualified, unfunded deferred compensation plans established by state and local government and tax-exempt employers
Taxpayer contribute pre-tax dollars and isn’t taxed until the money is withdrawn, usually for retirement.
What is NUA?
A strategy for retirement asset distribution
Applies to employer securities held in a qualified retirement plan (ESOP, pension, 401K, etc.)
Means to trade ordinary income taxation on retirement assets for long-term capital gains treatment
How does NUA work?
Must elect lump sum, in-kind distribution from plan (full distribution in 1 year)
Original basis (i.e., contributions to plan) immediately taxable as ordinary income
Remaining value (Net Unrealized Appreciation) taxed as LTCG
Subject to premature distribution penalty rules for qualified plans (applies only to original basis)
No step-up of basis at death on NUA portion.
Subject to Income in Respect of Decedent (IRD)
Are there voting rights with restricted stock?
Yes
Advantages of Restricted Stock?
▪ Good for high performers— employees meet targets before receiving shares
▪ Can carry dividend or voting rights
▪ Retains some value for employees even if price declines
▪ Capital gains treatment available on gain with 83(b) election
▪ Requires fewer shares to provide a similar level of benefit
Disadvantages of restricted stock?
Restrictions may make ownership seem like an unlikely benefit
Company cannot take a tax deduction for the value of the gain employees realize with 83(b) election
Subject to variable accounting rules, requiring changes in value be charged as compensation expense
Can involve risks for employees if 83(b) election made
What are the sells stock under provisions of Rule 144:
Holding Period: One year if non reporting company, 6 months if reporting
Trading Volume: Number of shares sold during a 3-month period can’t exceed: The greater of 1% of outstanding shares of same class being sold or if class is listed on stock exchange or quoted on NASDAQ
The greater of 1% or the average reported weekly trading volume during the 4 weeks preceding the filing a notice of the sale on Form 144
Filing Notice with SEC: Must file notice with the SEC on Form 144 if sales involve
more than 5000 shares or the aggregate dollar amount is greater than $50,000 in any 3-month period.
What are 5 strategies for diversification?
Variable Prepaid Forward Exchange Fund Purpose Loan Collar with Purpose Loan Custom Diversification Collar
What are 4 liquidity strategies?
Restricted Stock Sale
Writing OTC Covered Call
Variable Prepaid Forward
Loan
What are 3 hedging strategies?
Purchase OTC Put Option
Zero Premium Collar
Participating Collar
What is Zero Premium Collar
Investor wants to continue to own underlying equity but hedge price risk
Purchases put option and sells call option against holdings for net zero premium
Specifies option maturities and degree of downside protection and upside appreciation
What occurs when an investor borrows shares of stock and sells them short, while at the same time owning shares in the same stock.
Short Against the Box
Rules have been established to make this strategy (within certain constraints) illegal, but new strategies have been developed to accomplish the same goals.
What is a Prepaid Variable Forward
strategy used by stockholders to cash in some or all of their shares while deferring the taxes owed on the capital gains
This strategy is typically used by investors who own a large number of shares in a single company and want to raise cash while postponing taxes.
The sale is not finalized. That’s an advantage for holders of stock options with a later exercise date.
What are the advantages for a prepaid forawd?
Substantial liquidity generated upfront
No tax event until maturity
Provides floor for stock price
Investor retains ownership, dividends and voting rights until maturity date
What is a 10b5-1 Plan?
Pre-arranged trading plans for insiders and affiliates
Specifies amount, price and date at which securities should be traded
Allows trading during “blackout periods”
May provide public with greater disclosure
Terms to know
Incentive stock option (ISO) ▪ Non-qualified stock option (NSO) ▪ Disqualifying disposition ▪ Section 83(b) ▪ Restricted stock ▪ Rule 144 ▪ Section 10B5-1 Plan ▪ Zero premium (cashless) collar ▪ Short against the box ▪ Exchange fund ▪ Prepaid variable forward ▪ Stock swap (pyramiding) strategy
