My main expertise lies in making money disappear and putting too much on my credit cards. However, as I’m getting older I need to start making smarter financial decisions.
Here is my query: my spouse has a bunch of stock from her employer that’s about to vest. She wants to sell it immediately and start paying down our debt. This sounds smart to me but I’m concerned about getting dinged on capital gains tax. Is this something we should be concerned about? I read online that there is some exception for things owned for two years. Does this mean if we hold on to the stock for two years, we will reduce our tax liability?
In general, is it a good idea to offload your employer’s stock so you don’t end up like those Enron employees who were stuck with massive but worthless investments? Unfortunately, I really don’t know much about stocks.
Oh, I should have mentioned first, I live in the US so I’m asking about US tax laws. Thanks.
The tax issues depend a lot on the rest of your income, but the short version is that long-term gains are taxed at 0% (if your regular bracket is 15% or less) or 15% (if you regular bracket is more). There’s a 3.8% NIIT surcharge at 250k AGI, and at 450k AGI, the Bush tax cuts expire, making the base rate 20%.
Short term gains are taxed at your ordinary income rate (somewhere between 0% and 35%), with the same 3.8% surcharge above 250k AGI.
But the tax only applies to the gains. Depending on the terms of the vesting program and the direction the stock is moving in, we don’t know how much you’ll have in gain. Heck, you might even be selling the stock at a loss, and you can subtract 3,000 of capital losses from ordinary income, reducing your tax.
So here’s a real example from this morning’s meeting with a tax client: 115,000 of vested options from his employer. Gains are only about $10,000. He’ll pay 28% because of short-term treatment (instead of 15% if long-term), so the cost of selling quickly is $1300 of tax. But he intends to use the money to pay off his mortgage, which saved him about $4,000 in interest over 12 months. This has a tax “cost” of its own, since he has about $1200 more in tax due to lower deductions. But even then, a $2500 tax cost to save $4000 in interest is a reasonable decision
Thank you for your response. We are currently paying usurious credit card rates, so based on what you’re telling me about capital gain rates, selling will almost certainly save money in the long run.
The stock is a fair amount more valuable now than it was, which is one of the reasons we are eager to sell. It could go straight back down again.
Money in the hand is worth more than more money in the bush - when you have somewhere more needed for that money to be. (Leave it in the bush in a diversified fashion long term once you have spare money - but options fail the diversified rule anyway).
And the thing with options is that you usually can’t take them when you leave a job, so selling them now when they are worth something is infinitely better than having them in your hand, having the company hit a rough spot, getting laid off, and having options that are under water. (I watched a LOT of my coworkers have that problem in 2009).
I had a lot of theoretical money in 2000 - and not nearly as much theoretical money in 2001 because I waited. And I didn’t even have debt to pay off. So these days I sell immediately. When I sold my newly vested options in July near the high, I was highly pleased when the stock went down soon afterwards.
Is it stock or stock options? If options, you still have to have the money to exercise the options. You can borrow that, but it gets more complicated if you want to hold them.
I’m not a tax expert, but I believe if your gain is based on the company giving you the stock for free or at reduced cost, that gain is not a capital gain but is ordinary income. The capital gain (or loss) is based on the difference in price between the price when you first came into possession of the stock and the ultimate selling price. It’s not clear from your OP which gain you’re referring to.
When you exercise and sell for my company they withhold taxes from the receipts, so I’m pretty sure this is correct.
And you should always exercise and sell. During the Bubble, many people around here held onto stock after they exercised, stock that was a lot higher than the option price when exercised. When the bottom fell out they found they had giant tax bills and stock that was not valuable enough to cover them. That was a mistake I didn’t make at least.
That’s a good point. I didn’t address it in my post because people often have little control over the timing of this. (Though, as always, individual situations do vary.) Often, the W-2 reported income tax from company stock options happens at the time they are vested, even if you do not exercise them. For many people, vesting occurs automatically at so many years or months of work, and the only timing portion they control is the element covered by capital gains tax.
The significance is because fear of paying capital gains is a consideration for the OP in deciding whether to sell. If they think the entire profit is capital gains when in reality little or none of it is, then they would be making an incorrect assessment of the pros and cons.
You do whatever maximizes your rate of return. For example, say you have all of the following:
Credit card debt that comes with a 15% annual interest rate.
A mortgage that comes with a 5% annual interest rate.
An investment account that yields 8% a year
Your general plan for any extra income would be:
Pay off credit card debt, since this would give you a return of +15% on your money (you no longer have to pay the 15% interest; you “get the interest payments back”)
Invest in your investment account (+8%)
Pay down your mortgage (+4%, again “getting your interest payments back”)
This is the general idea. In reality, there are complicating factors. Mortgage interest may be tax-deductible, so you may not really get a full 4% benefit in paying down your mortgage. You want to have some money in a savings account as a safety net. Investments are subject to capital gains taxes. And so on.
As far as the vested stock goes, capital gains would not generally come into play regarding whether or not to sell immediately (check the stock program details to be sure). Usually, vested stock at most companies is handled on a time-based schedule, e.g. “After you work here for <X> years, we will give you 100 shares of company stock.” Such stock grants are treated as ordinary income and taxed on the vesting date. e.g. “the 100 shares have a market price of $50/share, so you will be taxed on $5000 of ordinary income”. What actually happens is that you receive 80 shares (or what have you) instead of the full 100; the “lost” shares are the tax withholding. At that point, after you have paid your taxes and received your remaining shares, you decide whether to hold or sell. Hold if you think the stock price will increase quickly and give you a greater return than other options. Otherwise, sell and use the money towards whatever option gives you the greatest rate of return.
Thank you to everyone for the advice. I didn’t realize that it might be counted as regular income. That would simplify everything. One thing is clear, we need a lot more fiscal discipline to avoid being in this situation again. I want to be able to afford one of those nursing homes where they actually flip you every once in a while.
I’ve never ever had a W2 generated when options vested, only when they were exercised, which involves paying the strike price. Remember, vested options can be underwater.
That was mostly an issue confined to those with ISO-type options where the amount was enough to go into AMT territory. They ended up having to pay tax on the gains, but if the stock dropped by tax time, they wouldn’t be able to pay the bill. The losses could be deducted–but only at a certain amount per year (somewhere in the ballpark of $10k, IIRC). So they might have had $100k of taxes that they would only get back after many years.
I could easily have gotten bit by this, but arranged my exercising so that I was just under the AMT threshold. Pretty dangerous situation. I think they’ve fixed it since then, but haven’t looked into it since my company no longer issues ISOs (or any options for that matter). I think other companies around here have done the same, so it’s not as much an issue.
I avoided that issue by exercising the ISO options and selling the resulting shares in one transaction. As I remember, the gains were treated as ordinary income.
Typically called a “same-day sale.” Downside is that you lose the benefit of the ISOs as compared to NQ options (i.e, that if you hold the stock long enough you only pay long-term capital gains tax).
I used a mix of same-day-sale and exercise-and-hold; the tax benefits are non-negligible, but you definitely want some way to ameliorate the risk.
That’s it. It has been a while and I avoided the issue by not selling enough options. They dramatically changed the tax implications of issuing options (or started enforcing them) so they’ve pretty much dried up. My company, which was quite big, gave pretty much everyone some options. No more.
They dramatically changed the tax implications of issuing options (or started enforcing them) so they’ve pretty much dried up. My company, which was quite big, gave pretty much everyone some options. No more.