Awarded Equity In Your Company? 5 Key Financial Considerations

By Ken Mayer and Richard Bloom, CFP®

As we approach the end of the year, bonuses and tax planning are at the top of many employees’ minds. Without proper planning, equity
compensation grants can seem like a double-edged sword. On the one hand, the equity grants you’ve been awarded represent the
potential for significant wealth. On the other, they may have a range of complex financial and tax planning considerations. So, what should you be thinking about when managing your equity compensation? Here are five important things to consider when strategizing with your team of professional advisors on how to manage your equity compensation grants.*

1. Make sure you know what kind of equity grant you’ve received.
Knowing what kind of equity grant you’ve been awarded will help you understand when and how you may owe taxes. Nonqualified stock options (NQSOs) are a common type of equity grant that are awarded at a pre-determined exercise price, also known as the strike
price. Other types of equity compensation may include incentive stock options (ISOs), restricted stock units, and performance shares.

2. Keep track of when your equity compensation grants vest.
The vesting period defines the amount of time you must hold the equity grant before it vests and generally is no longer forfeitable. Typically, the equity grant will vest over a period of time, achievement of performance goals or a combination of both.

3. Understand the tax consequences of your equity compensation grants.
NQSOs do not qualify for special tax treatment so the spread between the strike price and the fair market value (FMV) of the stock at the time of exercise is considered ordinary income subject to federal, state, and local income taxes and payroll taxes. ISOs do not generally
result in taxable income when they are exercised, but they may result in ordinary income or capital gain at the time the shares are sold depending on how long the shares have been held. However, the spread between the strike price and the FMV of the stock at the time of
exercise may be considered income for Alternative Minimum Tax (AMT) purposes.
With restricted stock units or stock performance awards, you are generally subject to ordinary income tax when the equity grants vest. e type of equity grant and terms of your company’s plan will determine when and how it is settled and taxed.

4. Determine whether a section 83(b) election makes sense for you.
If you make a section 83(b) election, you recognize taxable income in the year the equity award was granted, rather than in the year it is no longer subject to a substantial risk of forfeiture. Typically, a section 83(b) election can only be filed in connection with the grant
of certain types of equity awards, such as, restricted stock and performance shares. e section 83(b) election needs to be made within 30 days of receiving the equity grant. If you choose to make a section 83(b) election, you will recognize ordinary income on the excess of the FMV of the equity award at the time of grant over the amount paid, if any. By making an 83(b) election, you have the potential of reducing your overall tax paid if your company grows. When you eventually sell the shares underlying your equity award, you may
recognize capital gain or loss. Assuming you sell the shares more than one year after grant, any gain would be treated as a long-term capital gain, which is taxed at a lower rate, than ordinary income.

5. Find out if your shares qualify as Qualified Small Business Stock.

You may be able to exclude up to 100% of any gain from the sale or exchange of qualified small business stock (“QSBS”) acquired after September 27, 2010 and held for more than five years. e maximum amount of gain excluded is generally allowed up to $10 million or
ten times the cost of the stock. e five-year holding period is for shares—not options—so if QSBS treatment is a future possibility, exercising options early and along the way may make sense. It may also be useful to negotiate an accelerated vesting schedule to
start the clock on the holding period. QSBS rules are complex and include some key requirements for taking advantage of this exclusion, so consulting a tax advisor for guidance is advisable.

Key Takeaways
Deciding how to manage your equity grants can be a complex undertaking, especially if they are a significant component of your compensation package and your company stock represents a large portion of your overall wealth. Understanding the financial and tax implications of your equity compensation—and how they impact your comprehensive wealth management strategy—is critical. Working closely with your professional advisors—including your CPA, attorney, and a financial advisor who understands the nuances of equity
compensation plans—can help you create a customized plan for achieving the future you envision for yourself and your loved ones.

About the Authors

Ken Mayer and Richard Bloom, CFP® are Financial Advisors, Dedicated Equity Plan Specialists with the MayerGelwarg Group at Morgan Stanley. As Dedicated Equity Plan Specialists, Ken and Rich utilize a unique set of skills to help clients who receive compensation benefits in the form of company stock. eir deep understanding of the tax ramifications surrounding stock awards and grants qualifies them to work cohesively with clients’ CPAs to develop long-term, tax-efficient diversification strategies.They can be reached at 212-893-7592 or by email at Ken.Mayer@MorganStanley.com and Richard.Bloom@MorganStanley.com.

* Strategies are subject to individual client goals, objectives, and suitability. Morgan Stanley Smith Barney LLC (“Morgan Stanley”), its affiliates and Morgan Stanley Financial Advisors or Private Wealth Advisors do not provide tax or legal advice. Only US federal income tax information is provided herein, and other taxes may apply depending on an investor’s particular circumstances. Investors should consult their tax advisor for matters involving taxation and tax planning and their attorney for matters involving trust and estate planning and other legal matters.
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