For decades employers have sought to improve the ways a company can motivate, retain and compensate valued employees.  The two main types of employee stock option programs are Incentive Stock Options and Non-Qualified Stock Options.  The main difference between these types of plans for a participant concerns the tax treatment at the time of exercise and sale.

The Incentive Stock Option incurs no income tax at the time of exercise, however in order for the participant to receive capital gains treatment upon sale the holding period must exceed one year, otherwise the gain is considered ordinary income for tax purposes.  This particular tax preference given to the Incentive Stock Options requires that the exercise be considered for the AMT calculation. The AMT Income is the difference between the grant price and the fair market value on the date of exercise.  The AMT tax rate is 28% of the gain described above and is due if it exceeds the tax using the standard method.

The Non-Qualified Stock Option incurs an income tax at the time of exercise. The gain is taxed as ordinary income on the difference between the grant price and the fair market value on the date of exercise. The marginal tax rate for ordinary income can reach 39.6% and is many times the case when this income is added to earned income. The tax treatment upon sale receives capital gains treatment; the one-year holding period is required for long-term status.

The risks faced by all employee stock options plan participants who have exercised options are the same.  The concentration of your retirement “nest egg”, which represents for many a “lifetime” of work, into a single stock can be disastrous. For many there is a lack of understanding that to tie one’s fortunes so closely to the company they spent so many years working for could result in the loss of one’s financial lifestyle.  It is these uncertainties and risks that an individual would want to avoid. So what purpose could a financial advisor serve, if it was not to protect against these risks through the use of diversification and hedging techniques with the use of stock options. There is a specific duty on the part of the advisor and the financial institutions they represent to manage a concentrated portfolio and the unique risks associated with this type of an account.

For more information on employee stock options and the use of “cashless collars”, please click here to visit our Newsroom and review articles such as a feature atricle by Dr. Donald Moine, a securities expert in stock options, as well as other articles which discuss our firm’s involvement in employee stock option concentration cases.

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