Looking to Benchmark Pay?
Exercising Options
TARGET:
A uniform exercise plan that covers all the possible variables.
Cashless Exercise
Employees often perform a cashless exercise when, at the time of the transaction, they do not have adequate cash to exercise their stock options and outright purchase the stock. During this transaction:
- A broker will lend the money to the employee to exercise the stock options.
- The broker will immediately sell enough shares to cover the exercise price, taxes, and commissions.
- The employee then keeps whatever is left in cash or stock.
If the employee chooses to hold the stock, any future appreciation is taxed as capital gains when the stock is eventually sold.
Stock Option Worth
What is the value of a stock option? There is more to consider than the trading price.
Let's take a look:
Mary has an option to buy 500 shares of her company's stock at $40 per share. It's now trading at $100 per share. With a market value of $50,000 (500 shares x $100), Mary can just afford that down payment on her dream home if she executes a cashless exercise. Well, maybe not.
Mary forgot to subtract the exercise price and taxes from the stock value.
Stock Value - (Exercise Price + Taxes) = Net
$50,000 - [$20,000 + 0.35($30,000)] = Net
$50,000 - [$20,000 + $10,500] = Net
$50,000 - $30,500 = $19,500
After deducting the exercise price ($20,000) and then federal and state taxes (35% of the gain on her investment), Mary will probably net somewhere in the ballpark of $20,000. That's quite a difference from $50,000.
Note: Taxes are paid based on the profit made on the sale of stock. So, if $1,000 worth of stock is purchased and then sold the next week for $4,000, there would be a tax on the $3,000 gain.
Memory Jogger
Nina has the option to buy 1,000 shares of her company's stock at $30 per share. The stock is now trading at $80 per share. If Nina exercises her options now and pays 40% federal and state taxes on her gain, how much will she be left with?