- Taxes are often a concern for employees with stock options.
- Investors may consider accelerating income into a lower-tax year by selling stock or exercising non-qualified stock options.
- However, investors need to consider their complete situation before making any moves, financial experts say.
Taxes are often a concern for employees with stock options, which is the right to buy company stock at a specific price for a set period.
However, if someone earned less in 2021 or expects to make more in 2022, they may consider ways to accelerate stock-based income before year-end.
For example, someone may sell stocks to lock in current rates. Or they may buy, known as "exercising," so-called non-qualified stock options, a type of employee compensation that triggers regular income tax when purchased.
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However, there are several factors that employees need to consider before making these moves, according to financial experts.
"There are a lot of moving parts, depending on the type [of stock options] you have, tax implications and other personal scenarios," said certified financial planner Daniel Zajac, partner at Zajac Group in Exton, Pennsylvania.
Exercise non-qualified stock options
Non-qualified stock options offer the chance to buy company stock at a set price, and employees may earn a profit if the value has increased when they decide to sell.
However, when employees exercise, they owe regular income taxes on what's known as the "bargain element," or the difference between the current stock value and exercise price, which may create a hefty tax bill.
"People are very aware that it is a taxable event," said Kristin McKenna, CFP and managing director at Darrow Wealth Management in Boston. "They are not aware that withholding is done at these flat rates, and it's probably not enough."
But more important, employees need to consider if exercising stock options aligns with their financial goals. There's an opportunity cost of spending money upfront, and owning a large stock concentration for a single company may be risky.
"How do you feel being an owner and a shareholder of this company right now?" asked Chelsea Ransom-Cooper, CFP and managing partner at Zenith Wealth Partners in New York.
"The biggest thing that I remind clients is it's not all or nothing," she said, explaining someone may have time to spread out purchases or make a decision in the future, depending on stock option expiration dates.
Sell previously held stock
Selling company stock is another way to accelerate income into 2021. But advisors typically consider more than taxes when deciding to offload shares.
"Tax is just one part of the equation," said Zajac, explaining someone may decide to sell stocks to fund another goal or they may be eager to diversify their investments.
Moreover, selling another type of compensation, incentive stock options, may add another layer of complexity.
Although incentive stock options don't create regular income tax at exercise, the bargain element – or difference between the current stock value and exercise price – creates an adjustment for the so-called alternative minimum tax, a parallel system for higher earners, that may cause a bigger tax bill.
When dealing with incentive stock options, advisors may need to run tax projections to help clients decide the best move.
"I always recommend talking to a tax advisor and a financial planner before doing anything," McKenna added. "You can't undo these things once you've done them."