Tax Treatment of Employee Stock Option -- Fair? Unfair?

[igorlord]

Inspired by: http://angerona.livejournal.com/665475.htmlWhat are the employee stock options? Are they a mere "promise of a bonus" or a "valueable investment position"? I know the IRS's answer. But I am after reasons/logic/fairness here

Comments

[gladiolux]

I think you meant a call option (those grow in value with the stock price)

Having never looked at it, I'd guess the IRS position is #3.

If the company gave the actual tradeable calls as bonus then it would make sense to tax them at that point (because their price would be known and the employee could for example sell them at this price straight away). In real life, when the company often isn't even public, I guess it's hard to price such an option (although 0 seems a good guess)

[igorlord]

Thanks, yes, Call options. I've fixed that.

Yes, IRS position is #3, which is not necesserelly fair. The fact that it is hard to determine a price does NOT mean that the price is 0.

The options are VERY valuable, even without being able to resell them.

Let me ask you: would you rather get $10 or an option to buy 100 shares of some given large company X stock at today's market price any time in the next 10 Years or as long as you stay with yout present employer? What about $20? $100? $300? There is a value!

[gladiolux]

Of course it's not exactly zero (for a listed company), I was joking. Although I'd choose a tenner anyway.

Also I would rather Uncle Sam stayed away from my relationship with my employer (penalising me for leaving)

Anyway you're probably thinking about Jack Welch and his millions of GE options (or some such, I'm not exactly sure). My guess is that a programmer with 5000 options in his XYZ startup has as much chance of a windfall as someone landing in Las Vegas. Would you rather the IRS taxed everyone on arrival?:)

[igorlord]

Well, I am thinking of the very real programmer with his X options in a very large public company. I am further thinking of that programmer having to excersise all of his options accumulated over 8 years when leaving that company, pushing his tax braket to the highest in this Nation, and because of it, missing on all the deductions he would normally take, including even the freaking deductions for the State income taxes paid! Hardly Jack Welch but it still hurts a LOT!

[edashevs]

As shameful as it is, i have to admit that I agree with IRS, employee stock options are more like bonus than like investment for the following reasons

[igorlord]

1) Yes, this is just what I proposed as one way of looking at it -- "a promise of a bonus"

2+3) Even if we look at the Options as "something whose purpose is compensation" (which is already an interesting twist -- treating something for tax purposes not as it IS but what it is FOR), then the question is, again, WHEN was that compensation paid? Was it paid when the company granted you an Option for 1000 shares instead of an Option for 400 shares granted to Joe? Or were you compensated only when you excersised the options?

Do you think that the tax treatment would be any different if a hypothetical company would be granting Options identical to the today's employee options but on S&P500 indez instead of the Company stock (with all the requirments of no resale and termination when you leave the company)?

[svechka]

я, признаюсь, в этом всем чайник, но с точки зрения получения бонусов ежегодно vs exercising your stock options all at once when you left the company - ведь теоретически, ты мог выкупать options are they vested, right? So in effect it was your decision to buy exercise them all at once :) (i'm not placing the blame, just theorizing!)

Отсюда следующий вопрос: if you bought them as they vested and held them, what would you be taxed on? The spread between your strike price and the market price on the day when you exericised? If that's the case, woudln't it make sense to exercise them when the market price is low?

Дальше - если ты выкупил options и держал их хотя бы год, а потом продал - на что берется налог?

в общем я просто задумалась, потому как у меня тоже есть vested options that have not been exercised, и возможно надо по этому поводу почесаться :)

[igorlord]

ты мог выкупать options are they vested

But that makes little economic sense to do. Options are not stocks.

If the options were vested immediately, they would be worthless when they vest anyway. An Option (a Call Option like the ones we are given) is a right to buy 1 share at the set price (the market price on the day the option is granted) any time within 10 years or until you leave the company.

If the option is vested right away, it has no value to you -- you can just buy the stock at the market price yourself; no need to use the option.

The whole value of the Option is its Time Value -- you do not have to put the money down today and can enjoy the same growth as if you did buy the stock and held it. Also, if the stock declined from today's value, you are protected -- you just do not use your option.

[svechka]

а, поняла - у вас речь идет о совсем других options
never mind :))

[angerona]

The spread between your strike price and the market price on the day when you exericised? If that's the case, woudln't it make sense to exercise them when the market price is low?

That's like saying that one should get a job paying as little as possible, because then they'd pay less taxes :).

[anonymous]

This treatment of options is actually beneficial to the employee in most situations - you get to defer your taxes! If you got regular cash bonus, you would be paying income tax each year; with options you get to defer the tax until you exercise. Option vest and expiration schedules tend to be stable, so options you got in 1995 vest in 1999 and expire in 2005, while those you got in '96 vest in '00 and expire in '06. So, as long as you stay with you employer and hold the options to expiration, you get to defer the taxes without impacting your tax bracket.

This is only a problem if you hold all of your options, exercise them all at once and there are enough of them to cause you to move to a different tax bracket. Compared to the issues with qualified stock options, where you can actually lose money quite easily, this is a great situation.

And as far as the state tax deduction - all the deductions phase out after a certain threshold, and then there's always AMT, which disallows all state and local taxes.

[inostranka]

this was me

[igorlord]

http://igorlord.livejournal.com/24375.html?thread=175927#t175927

[igorlord]

Btw, do you know, just off the top of your head, if the reduction in deduction can be claimed as a deduction next year?

[danillo]

off: а куда вы все исчезли? в отпуск уехали?

[igorlord]

Уже вернулись. :)