Stock Options Portland State University MBA Program

Stock Options What are they? How do they work? What are some tax issues?

Disclaimer (of course) This presentation is general and not intended to give legal advice to specific employees Employees will have their own unique circumstances and should consider consulting with their own tax or accounting advisors

What Is a Stock Option? The right to buy the company’s stock at today’s price Not stock Later, when the stock is more valuable, you can exercise the option to purchase the stock at a discount

How Does the Stock Option Work? Vesting Exercise Transfers Holding Period

Vesting There is a vesting schedule attached to each option agreement The vesting schedule describes the earliest date that an option can be exercised Vesting doesn’t issue shares – just allows the purchase of shares Must remain an employee through the dates described on the vesting schedule to earn the amounts vested

Vesting Example: –After one year, 28% of the options become vested –After each following month, 2% of the options become vested, for 36 months –After four years, all options vested

Vesting Acceleration –Some unvested shares may become vested in some circumstances Death or disability Certain change of control transactions Potentially gives employee the right to buy more shares than described in standard vesting schedule

Vesting Summary: –Specific acceleration rights that might apply in the event of a termination or acquisition

Exercise Exercise by paying the purchase price for the shares that you want to purchase Can exercise all at once, or several times Not a shareholder until the option is exercised Consult with the company to discuss ways to pay for the shares

Exercise Timing: –The option expires 10 years after the grant date –The option expires 90 days after termination of employment –After the option expires, the right to purchase the stock is lost

Exercise An option is an option not a mandatory Exercising options is an investment decision After you exercise, you are a shareholder Receive shareholder notices Share in the upside (or downside) along with the other shareholders

Exercise Summary: –Exercising an option is investing in the company –Consult with the company on how to make that investment –Be careful about the expiration of the option

Transfers Options can’t be transferred –The agreement is between you personally and the company What can you do if you need to transfer an option? –Exercise the option and transfer the shares instead? –Enter into an agreement assigning control of the option to a third party? –Must consult with the company to find a solution

Holding Period If you have an Incentive Stock Option: –After you exercise the option, you must hold the shares for one year after exercise, and –After you exercise the option, you cannot sell the shares until two years after the date of the option grant

Holding Period If you sell early: –Tax consequences, discussed below

Tax Issues Date the company gives you the option Date you exercise the option Date you sell the stock

Tax Issues Date the company gives you the option –Incentive Stock Option (ISO): No income to employee –Nonqualified Stock Option (NQ): No income to employee … usually

Tax Issues Date you exercise the option –ISO: No income … usually –NQ: Income = (the value of the stock on the exercise date) – (the exercise price of the option) –Therefore, if you exercise a NQ option, you should be prepared to pay taxes –Consult with a tax advisor before exercising option

Tax Issues Date you sell the stock –ISO: Income = (sales price for the stock) – (the exercise price you paid) Because of the holding period, this should be taxed as capital gains for the shareholder –NQ: Income = (sales price for the stock) – (the value of the stock on the exercise date) May be capital gains or ordinary income depending on circumstances –When you sell stock, you should be prepared to pay taxes –Consult with a tax advisor when selling stock

Tax Issues Early disposition of ISO shares: –Income = (the value of the stock on the exercise date) – (the exercise price of the option) This will be treated as compensation (ordinary) income –Plus: Income = (sales price for the stock) – (the value of the stock on the exercise date) May be capital gains or ordinary income depending on circumstances –Again: Consult with a tax advisor when selling stock

Tax Issues Summary: –For ISOs, usually no income is recognized until you sell the stock –Income would be the gain on the stock, likely at capital gains tax rates –Consult with tax advisor

Good News An option will be valuable to an employee if the value of the company’s stock goes up Employees have a direct personal incentive to increase the value of the company’s stock Employees get to share directly in the value they help create for everyone

James N. McDermott Ater Wynne LLP 222 SW Columbia St., Suite 1800 Portland, OR (503)