Can I Cash My Employee Stock Options?

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Back to main Resources page Exercise Rules for Stock Options How to Avoid Tax Pain when Exercising Stock Options Stock options are an increasingly popular "benefit" offered to employees, but if you're not carefuland plenty of dotcommers weren't a few years ago-your options can cause you more financial pain than gain.

Here's how to make sure your options are a profitable exercise: There's should i sell my stock options breed of options called Incentive Stock Options ISOs but they are typically reserved for high-end execs. And that means you need to understand some tricky tax rules. You owe absolutely no tax on the options until you choose to exercise the options. The Exercise Price is the market price on the day you choose to cash in your options. Typically when you receive a stock option grant your shares vest over a set period; 25 percent a year over four years is common.

That means that after the first year you could exercise 25 percent of your grant; after two years you could exercise should i sell my stock options percent etc… At the end of the fourth year all the options would be yours.

It's typical to have 10 years from the initial issue date to exercise the options. And the screwy fact is that even if you own the options for a couple of years, the gain you get on the exercise date the difference between the grant price and the exercise price is going to be taxed as ordinary income. You don't get to opt for the lower capital gains tax rate, which is 15 percent for most folks.

Okay I bet an example would help here. Now listen carefully, because here is where so many dotcommers got hammered. And as I mentioned a second ago, you owe tax at your ordinary income tax rate. What trips up so many folks with NQSOs is that they exercise and continue to hold the stock because they think it is going to go higher, and they figure if should i sell my stock options hold for another year they will be able to reduce their tax bill since they will qualify for the long-term capital gains tax rate should i sell my stock options either 10 percent or 15 percent.

That's simply wrong, wrong, wrong. If you do hold onto the stock you still owe income tax on the gain you got on the date of the exercise. Only the gains after the exercise date are eligible for the capital gains tax rate. And here's the real problem: Don't think you can call it a wash.

So here's your best options option: When you exercise your options I think you should sell immediately. This is known as a cashless transaction. It guarantees that should i sell my stock options "book" the profit. Then you can decide what to do with all that money; put it in a savings account for your home down payment, pay down your credit card debt, should i sell my stock options invest it in stocks or mutual funds for the long-term.

Not only does this assure you won't fall into the tax trap, it also forces you to wisely diversify. Look, I hope your company-and its stock-continues to do well, but as I mentioned in the book, no single stock should account for more than five percent of your assets. If you are over reliant on a single stock-be it your employer or not-you are taking on too much risk.

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