Finance Joby Aviation
Fly high with stock options. Joby Aviation creates quiet, electric-powered, pilot optional, air taxis for our future right in your backyard (Marina airport). Phantom stock is a cash bonus related to the value of company shares, but they don’t know when cash settlements happen. (Courtesy of Joby Aviation)

To design the coolest toys in the smallest boxes, local tech firms offer engineers and managers not just quarter-million-dollar salaries, insurance and 401(k)s—but discounts or call options on stocks. This strategy eases corporate cash flow to gain and retain the brightest engineers and managers in the world.

Employee Stock Options raise frequent tax preparer questions and I have helped many bright engineers who missed deductions or needed IRS defense. What are highflyer taxes on SARs, NQSOs, ESPPs, ESOPs, RSUs and ISOs?

SARs and NQSOs are taxed as ordinary income at exercise on W-2s and 1040s, with no tax at grant date. To employees, this is ordinary compensation.

Non-Qualified Stock Options (NQSOs) can be issued to employees, contractors, directors, etc., at any time and in unlimited quantities—to those who seek appreciation. Stock Appreciation Rights (SARs) benefit employees when stocks appreciate, and both these packages pay in taxable cash.

Employee Stock Ownership Plans (ESOPs) are values of stock shares granted to employees based on duration of employment and vested over time with hopes that employees will share the interests of stockholders in long-term company performance with payment at retirement.

Employee Stock Purchase Plans (ESPPs) simply allow employees to purchase company stocks at discount prices with limits capped by salary. The discount in pricing will be taxed as ordinary income, either on the W-2 or the 1040, if employees hold for less than a year or notably as capital gains if they hold longer than a year from exercise.

Companies give trusted employees Restricted Stock Units (RSUs) freely. These are non-transferable and unsecured promises to grant shares until vested and can be forfeited for bad performance; vesting may take years. These defer tax slightly because they are not taxed at grant, but at vesting, yet they are taxed as ordinary income.

Employees may do some tax planning with RSUs if they can control the timing of vesting. Typically, hoping to spend cash or diversify stock holdings, employees sell RSUs a few days after vesting and usually the tax consequences are slight losses due to brokerage fees.  

Employees frequently overreport gains on RSUs because they fail to include all compensation for RSUs as basis. If employees retain company stocks, further gains will be taxed as capital gains. With sec 83(b) and no forfeitures, solid and optimistic employees can report ordinary income as of the grant date and take capital gains thereafter.

Only employees merit Incentive Stock Options (ISOs) and companies grant these as tax advantaged employee compensation without FICA taxes at a “strike price.” Employees can only gain $100,000 of these yearly and can only transfer them at death. If taxpayers wait two years from grant date to exercise their stocks and then hold them another year for a “qualifying disposition,” they may pay only the lower capital gains rates (maximum 23.8% rather than 37%) on hundreds of thousands or even millions of dollars in growing companies.

But there is a catch: taxpayers might owe Alternative Minimum tax on the difference between strike and exercise prices for shares not sold in the same year. (AMT may be recouped in later years.) At worst, the unlucky might pay AMT and watch the company shares’ value flounder or the company go bust. These tax rules keep stocks longer in the hands of employees who take risks for loyalty. Employees must exercise ISO’s within three months of termination (unless they are allowed to convert to NSOs).

Employees have every reason to be grateful for stock options and some have good reasons to hang onto company stocks, but planners bring warnings. Diminished liquidity and concentration of investments is dangerous, particularly in one’s workplace, should that company falter. Even Boeing crashed planes and Apple investors wondered what would follow Steve Jobs.  

So I advise risk-averse employees to slowly diversify their holdings into real estate or broader securities portfolios. Taxpayers have good tax reasons to hold onto ISOs and ESPPs, so generally RSUs should be sold first. The money is present to pay the taxes, but the game is the elfish joy of making cool Holiday toys as you guarantee your family’s long-term financial well-being. Fly high like Joby!


Robert Arne, EA, CFP, MS, of Carpe Diem Financial Life Planning, gives holistic financial advice as his client’s fee-only fiduciary. He serves mostly Santa Cruz Mountain dwellers. These articles must not be read as personal financial, mortgage, tax or investment advice; consult appropriate professionals. Learn more at www.carpediem.financial.

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Robert Arne, EA, CFP, MS, of Carpe Diem Financial Life Planning, is a Santa Cruz Mountains Certified Financial Planner who gives holistic financial advice as his client’s fee-only fiduciary. These articles are not personal financial, mortgage, tax or investment advice; consult appropriate professionals. Learn more at www.carpediem.financial.

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