Employee stock options can seem like a pie-in-the-sky career possibility to most young people starting a career. Sure, we’ve been inundated with the allure of working for a fast-growing and upwardly mobile tech company that pays big once an IPO rolls around, but the truth is, most of us will never have an option at an option. But still, this doesn’t mean you shouldn’t be prepared for the possibility, and a little understanding goes a long way.
Read through our list of important things to keep in mind about employee stock options below.
- Employee stock options are a right not an obligation. Just because you have an employee stock option available to you as an employee doesn’t mean you have to exercise it.
- The vesting period is the amount of time required before an employee can exercise a stock option. We’ll let Forbes explain this one: “An employer may grant 1,000 shares on the grant date, but a year from that date, 200 shares will vest (the employee is given the right to exercise 200 of the 1,000 shares initially granted). The year after, another 200 shares are vested, and so on.”
- Employee stock options are subject to specialized tax treatment. This is where employee stock options get complicated, so you should definitely speak with an accountant or carefully think about the taxation repercussions you’ll incur by exercising an option.
- Taxing of employee stock options commences at the time of exercise.
- There’s a difference between non-qualified stock options and incentive stock options. Non-qualified stock options are made available to both non-executive employees and external contractors or consultants while incentive stock options are generally reserved for executive employees. Moreover, unlike their incentive counterparts, non-qualified stock options aren’t subject to specialized federal tax treatment.
- Remember: stock options are often impossible to value precisely.
- Stock options can be “in the money” or “out of the money.” This CNN article sums it up nicely: “Whenever the stock’s market value is greater than the option price, the option is said to be ‘in the money.’ Conversely, if the market value is less than the option price, the option is said to be ‘out of the money,’ or ‘under water.'”
- Employee stock options should account for only a small portion of your overall investment plan. An employee stock option isn’t an investment portfolio, and you shouldn’t put all your eggs in that basket. Just like any other type of investment, your ESO should be part of a well-rounded portfolio, which likely means it should represent no more than 20% of your holdings.
- The longer you hold onto your stock options the more likely that you’ll be taxed less upon sale. If you decide to sell your stock option as soon as possible you’ll likely be faced with a significant short-term capital gains tax, whereas if you hold onto the stock, you may benefit from a long-term capital gains tax that could end up saving you thousands of dollars.
- Not all employee stock option plans are built on the idea of long-term ownership. And sometimes a stock option is made available by a company as a short burst of employee incentives.