What Issues Should I Consider Regarding My Non-Qualified Stock Options?

Stock options are a common form of equity compensation offered by many companies to their employees, officers, directors, contractors, or consultants. Non-Qualified Stock Options (“NQSOs”) provide a share in the potential appreciation of a company’s value. It is important to have a plan for deciding whether and when to exercise NQSOs and sell shares, as it requires cash flow analysis, complex tax planning, and a long-term strategy.

This checklist helps guide individuals when considering their NQSOs. It covers important issues to consider at the time of the grant, implications of exercising, tax considerations, and sale strategies. It also discusses the risks of concentration and diversification.

It's important to consider the value of the stock option when it is granted, the number of shares, and the vesting schedule. The vesting period can be based on the passage of time, the attainment of performance goals, or a combination of both. Once the stock option is vested, individuals can choose to exercise it, which means buying the stock at the grant price. The grant price is usually the fair market value of the stock at the time of the grant.

It is important to consider the tax implications of exercising NQSOs. The difference between the grant price and the fair market value of the stock at the time of exercise is considered ordinary income and is subject to ordinary income tax. If the stock is held for at least one year after exercise and two years after the grant date, any gain above the exercise price is treated as long-term capital gain. If the stock is sold before this time, the difference between the sale price and the grant price is taxed as short-term capital gain.

It's important to develop a plan for selling the stock, taking into consideration the individual's financial goals, cash flow needs, and tax situation. A concentrated position in a single stock can expose individuals to significant risk, and it's important to consider diversification strategies to reduce that risk. Selling the stock in a structured and thoughtful way can also help minimize the tax impact.

Overall, NQSOs can be a valuable form of equity compensation for individuals. However, it's important to understand the complexities of exercising and selling NQSOs and to develop a comprehensive plan that aligns with your overall financial goals.

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Robert J. Pyle, CFP®, CFA, AEP® founded Diversified Asset Management, Inc., in 1996 to provide personalized, comprehensive wealth management services to successful individuals, families, single women, and business owners. His specialty is addressing the complex financial needs of self-employed professionals, corporate executives, and small-business owners. Our disclosure can be found here. The views, opinion, information, and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc. Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting, or tax advice.