My Company Just Gave Me Stock Options. What Now?

So, your company just granted you stock options. You may be wondering what they are, how they operate and what you should do so.

First, allow me to congratulate you. Stock options may not make you rich, but if you don’t do anything crazy, they can’t hurt you.

Stock Options: Employee stock options are granted to key employees as incentives to help drive the value of the company up, which generally follows successful execution of the business plan. An option gives the employee the right—but not the obligation—to buy a share of company stock at a predetermined price (the strike price) for a term (usually five to ten years). At the end of the term, if the option has not been exercised (used to buy stock) it expires worthless.
Why be a fact that a Good Thing? The right, without the responsibility, to buy stock is a good thing because you are not bound to make any investment, to put any money at risk to participate in the increasing value of the company. For instance, if the strike price (the price at which you can buy shares of the company stock) is $1 and the stock price goes to $11, you have a profit based in of $10 per share. If you were granted 1,000 shares, your value would be $10,000. That’s a good thing.

Income is taxable: When you exercise your options, the I.R.S. generally takes the view that you’ve had a chargeable event. The assessable income represents the difference between the value of the stock and the strike price. In our example of an $11 share price with a $1 strike price, the taxable income would be $10—even if you don’t sell the shares. Because this income is on top of all of your other income, it will be taxable at your marginal rate, the highest rate you’ll pay in tax. That could easily represent one third of your option profit when you consider state and federal taxes.
Exercise When You Sell: Exercising (using your stock options to buy the stock) is a good idea only when you are ready to sell the shares of stock. Remember, even though your right to purchase costs you nothing along the way, when you actually purchase the shares, you will need to put up cash—unless you’re ready to sell. So just wait until you are ready to sell. Generally, your company will work with a broker to organize you to exercise the options without putting up the cash if you immediately sell the shares. You can use of cash to pay the taxes owed.

Exercise at expiration: The only other time to consider exercising your options is at expiration. If you can’t sell the shares (the company is private and there are no buyers) you may wish to exercise your options, but do with caution. If the options are in the process of expire and you are guaranteed the value of the shares is much greater than the strike price, you may wish to exercise the options and buy the shares with your own cash. Remember, you’ll need to not only pay the strike price, you’ll need to pay the taxes, too.

If your salary is large and your options are potentially worth hundreds of thousands of dollars—or more—are sure to talk to your tax advisor about the stock options when they are granted.