Author: Andrew Kabatchnick

Stock Options

Andrew Kabatchnick

The Ups and Downs of Stocks Options

 

You finally made it big!  You landed a job as a C-suite executive or manager level employee at a publicly traded company or a company that will soon go public.  As a part of your compensation, you are offered a nice lot of stock options for every year of service.  Now what?  How do you exercise the options?  When and how are you taxed on the granting, exercise, and sale of the options?  Stay tuned for a great deal of helpful information regarding your new stock options.

 

The Granting of the Stock Options

The first step in your journey is the granting of the stock options by your employer.  Often times, you will receive these options over time.  For example, if your employer grants you 100 stock options, you will be able to exercise 20 per year for the next five years.  Most commonly, you will receive incentive stock options for your service (shares held at least a year after exercise and 2 years after options were granted).  There is often no tax due upon the granting of your stock options, so there is not much to worry about now.  However, you are not off the hook indefinitely.  As we all know, the government will come for you one way or another.  Non-qualified stock options are usually granted to the higher-level executives, and are not as favorably taxed.  You will pay ordinary income tax rates as well as Medicare and Social Security (often not applicable due to income limits of these higher income earners) on the difference between the strike price and fair market value.

 

The Exercise of Stock Options

When you exercise your options (essentially purchasing the stock granted by your options), you are paying a pre-determined strike price (often times lower than the current fair market value).  During this time, if you were granted incentive stock options, you will not be subject to ordinary income tax rates.  You think you are in the clear.  Not so fast!  At this time, the difference between the strike price and fair market value will be subject to the AMT (often times 28%).  Although this is normally lower than the regular income tax rates, you will often be surprised that your state and real estate taxes, among other deductions, are not deductible when it comes to the AMT.

 

The Sale of Your Stock

Now it is time to sell your shares.  When you get to this point, it is similar to any other sale of securities.  Hopefully you have held the stock for more than a year, and you will be subject to the lower capital gains rates (most likely 15% or 20% depending upon your highest ordinary income rate), the 3.8% net investment income tax, and your state tax on the difference between the purchase price and sale proceeds.  Keep in mind that your AMT cost basis might be different than your regular cost basis due to the options already being subject to the AMT tax.

 

Summary

In summary, the granting of stock options can be a very exciting time, especially if you are new to the game.  There are several tax implications to be mindful of throughout the process, including being subject to the AMT when exercising and the payment of capital gains taxes on the sale of the stock.  If you don’t already have someone to assist you through the process, it is time to find an experienced and knowledgeable accountant.  I hope the above information was useful for you.  I look forward to assisting you with all of your future tax, accounting, and financial planning needs.

First blog post

Andrew Kabatchnick

Starting a New Business?  Proper Structure Can Save You Thousands

 

Starting a new business will be one of the most stressful and exciting times of your life.  There are many questions to consider.  For example, how will you get funding?  How will you market your product or service?  However, properly structuring your business can save you thousands of dollars in taxes as well as possible legal headaches down the road.

 

When starting your new business, one of the first decisions you will have to make is how to structure your new venture.  You can simply report all your income under your own social security number as a sole proprietor on Schedule C of your income tax return.  Alternatively, you can begin by opening an LLC and choose your method of taxation.  It is important to discuss the pros and cons of the various tax structures with your accountant.

 

A Limited Liability Company (LLC) is a simple business structure that allows you to reduce your liability if someone was injured due to a faulty product or procedure.  If you do not comingle personal and business funds, your liability is limited to the asset within your business.

 

Another important aspect of opening an LLC is the flexibility in tax structure.  While your company is in its young stages, you can simply remain as a sole proprietor (you only report your income and expenses on your Schedule C) while still maintaining your limited liability status.  This will keep down your reporting costs, cut out the need for payroll for shareholders, and allow you to streamline the tax reporting process.

 

As your business grows and your income level increases, you may want to consider having your business taxed as an S corporation.  An S corporation allows you to report your income and expenses on a separate business tax return (an 1120S).  This may allow you to have an additional layer of anonymity.  Although you are required to pay any active shareholders a “reasonable” salary, your net income is not subject to the self-employment taxes (the employer and employee portions of social security and Medicare taxes).  For example, if you have $50,000 of net income as a sole proprietor, you will be required to pay $7,650 in self-employment taxes.  However, with an S corporation, you would pay yourself a reasonable salary (let’s say $30,000).  You would only have to pay the 15.3% self-employment taxes on your salary ($4,590).  As you can see, you would save over $3,000 in taxes just from this simple example!

 

As an LLC owner, you can also decide to tax your business as a C corporation.  From a tax perspective, C corporations are very undesirable due to the concept of double taxation.  Corporate profits are taxed at a rate of approximately 35% while dividends paid to shareholders are taxed at their personal tax rates.  Although the C corporation has a more complicated tax structure, it allows more flexibility when admitting shareholders.

 

Starting a new business in this entrepreneurial climate can be very stressful and rewarding.  There are many factors to consider when opening your business.  One of the most important items is determining the proper legal and tax structure for your business. As you can see, status as an LLC and proper tax structure can possibly save you thousands of dollars in taxes as well as legal headaches.  You should consult with your trusted tax advisor to discuss your unique tax situation and determine the best methods for you.