Employee Stock Options, The Need to Knows

Employee stock options can be quite complicated. Stock options are not as valuable as actual stock. For example, if you receive 10 shares of stock worth $50 per share, this is essentially worth $500. On the other hand, if you receive 10 stock options with the option to purchase at $40 per share, if the stock is worth $50 per share, this is essentially worth $100 since 10*($50-$40)=$100.

According to www.investopedia.com, when your stock options vest, if you decide to exercise the options to obtain shares, you will pay taxes on the value (ie $100 in the example above) as if you received $100 cash (ie ordinary income).

When you go to sell the stock, you will also pay taxes on the gain. This can either be taxed as ordinary income (typically around 25% for most people) or if held longer than a year, taxed as a capital gain (typically 15%). In the example above, if the stock was held for 3 years and the price jumped to $70 per share, you would pay capital gains taxes on $200 since 10*($70-$50)=$200.

In general, if you hold more than 10% of your portfolio in a few particular stocks, you are already exposing yourself to high investment risk. In the case of stock options, when you exercise the options, you will also have to pay taxes in the same year, exposing you to the risk of not having the money to pay the appropriate taxes. You may want to consider this when deciding whether to pay ordinary income taxes or try to hold out to pay capital gains taxes.

This post was reposted from http://finlit.biz/retirement-2/employee-stock-options-the-need-to-knows/, originally written on May 29th, 2014.