By Patrick Duffy
I have stock options. I am thinking of selling them because I need the money. If I sell, how am I taxed?
G.R., Trenton, N.J.
People like you who receive stock options are lucky indeed, especially if you are with a good company, as you are, and the stock has done well, as it has.
However, one needs to be careful with stock options. The options when sold are taxable. Depending on the kind of options you have, when you sell the gain can be taxed either as ordinary income or as capital gains.
If you received what are called nonqualified stock options, your gain is taxed as ordinary income. This means it is taxed at your ordinary tax rate which in your case is 28 percent.
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If you receive incentive stock options which is the kind you have and you fulfill certain conditions, then your gain is taxed as capital gains. In your case, the capital gains tax rate is 20 percent, well below the 28 percent you pay on ordinary income such as wages, interest, etc.
The day you receive the options is called the grant day. The first condition to qualify for capital gains is that you must hold them for two years after the date of grant.
The day they officially become yours is called the exercise date sometimes called the vesting date. The second condition is that you hold them for a year after the exercise date.
Note you were not taxed on the options on either the grant or the exercise date.
From the information you have given me, both conditions have been fulfilled. Congratulations, you have saved yourself some taxes. You qualify for the lower capital gains rate.
Now the question arises: On what are you taxed? You are taxed on the difference between the option price and the sale price. For example:
# of shares Option Price Sale Price Gain
100 $15.00 $50.00 $(50-15) x 100
Capital Gains Tax @ 20 percent = $700
+ Estimated State Tax 175
Total Tax $875
So you might say, good I’ll have $2,625 or ($3,500 minus $875) left over. Not so fast, the options were granted to you so they have to be paid for.
So, if you need the money, maybe a more pertinent question is, what cash flow will you have if you sell the options? The option price will be deducted from the sale proceeds. Thus, what you will have "left in your hand" is
Sale Proceeds $3,500
Less Taxes 875
Less "purchase" price ($15×100) 1,500
Cash left $1,125
Now you face the question, should you sell or not? There are really only two reasons stocks ought to be sold. The first is when you need the money. The second is when you can get a better investment. The stock you own is among the best at the moment and seems likely to do well in the future.
That leaves the first reason. Do you need the money? From what you have said, you do. So sell.
You could hold on and the stock may increase in value. It could also, though unlikely, decline in value in the short term.
So either set a price at which you will sell or sell now. Otherwise, you could enter the "maybe it will go up more, maybe it will go down" zone, a very difficult zone for any investor.
Thank your lucky stars you were fortunate enough to work for a very good company in which you had the opportunity to avail of incentive stock options and look on it as a bonus for your contribution to the good performance of the company.
Patrick J. Duffy, M.S., CFP, is a certified financial planner practicing in New York City. He specializes in business and personal financial planning with the overall aim of enhancing an individual or family’s quality of life. His office is at 767 Lexington Ave., New York, N.Y. 10021. He may be reached at (212) 755-7736.
If you have a question related to business of personal finance, mail or fax it to The Business Section, Irish Echo, 309 Fifth Ave., New York, N.Y. 10016; (212) 686-1756.
Due to an editing error, the dates in last week’s "Business Matters" were incorrect. The date Jan. 4 should have been April 1.