In a previous article, we discussed the basics of stock options and stock units as they apply to equity compensation. We noted that companies—especially startups with limited cash resources—often use equity compensation to incentivize and retain key employees. By aligning the employees’ financial incentives more directly with the success of the company, the enterprise hopes to provide team members with reasons to give their best efforts toward building the company and making it thrive.

Over the years, the strategy of sharing ownership with employees has produced some notable success stories for both companies and their employees. Walmart Stores, for example, has for years encouraged employees to own company stock and even allowed stock purchases via payroll deduction. In similar fashion, employee-owned West Coast food retailer WinCo Foods has made headlines for the astounding success of its employee stock ownership program, which has made millionaires of scores of employees, from managers to produce workers.

However, such opportunities come with a few caveats, many of which revolve around taxation and diversification. In fact, these two matters are related, and the way they should be handled can change over the course of a career.

Early Years: Accumulation

For many young professionals at the beginning of their careers, the most important things to know are focused on how company stock and related options are obtained. During this period, matters like vesting schedules, strike prices, and the exact nature of the compensation are of paramount concern. How long must you work at the company in order to be fully vested? If you are receiving incentive stock options (ISOs), what is the strike price (the price for which you are guaranteed to be able to purchase the stock represented by your options) and how does that compare to the current value of the company’s shares? Are you receiving restricted stock units (RSUs, a common form of equity compensation) that must be held until a certain date before you can sell the underlying stock? Perhaps most important for those working for a startup company: What is your opinion of the long-term viability of the enterprise? Are you better advised to take a larger percentage of your compensation as salary, or do you believe that you are working for the “next big thing,” in which case you might prefer to forego a big salary now in favor of a potentially huge payout when the company goes public or is purchased by a suitor company.

As a young professional, understanding how your equity compensation package works is important for the design of your financial plan. Once you understand the key terms, important dates, and values, you’re in a position to integrate all this information into your financial plan.

Mid-Career: Surveying the Landscape

By this time, as you’ve accumulated experience and success, you need to begin looking at your equity compensation in terms of your total net worth and your medium- and long-term financial priorities. It may be time to begin selling a portion of eligible stock in order to begin diversifying your asset base. Of course, when you sell stock for a gain, you must pay either short- or long-term capital gains tax. So, if your option allowed you to buy stock at $10/share and the current market price is $20/share, you will owe capital gains tax on your $10/share profit from the sale. If you held the shares for at least a year, long-term capital gains will apply; this rate is usually lower than the marginal rate on your earned income. If you held the shares for less than a year, the gain is classified as short-term and will be taxed at the same rate as your earned income.

At this point in your career, then, taxation and asset diversification become important considerations. Because you must liquidate stock in order to diversify, it’s vital to consult with your tax and investment advisors about the most tax-efficient strategies. On the other hand, many companies offer the option to invest in company stock within the company-sponsored  401(k). If you own company stock within such a plan, the taxation issue may be less important, since it can be deferred until you actually begin taking distributions from the account. This can make the diversification problem easier to solve.

Ready for Retirement: Strategies for Unwinding

For those nearing retirement with large holdings of company stock and options, it is vital to consider the issue of diversification. However, this can be complicated by the emotions that sometimes accompany the ending of a long, successful association with a company. Selling company stock can feel like disloyalty to the enterprise or even like a denial of personal identity. It’s important to remember, however, that the reason you have the holding is because of your years of loyalty and effort on behalf of the company. It may help to think of unwinding the position as the company’s way of thanking you for all you’ve done.

As before, of course, the issues of taxation and diversification go hand-in-hand. If you have a large, concentrated position in your company’s stock, it is important to diversify in order to reduce the amount of risk to your financial well-being posed by exposure to a single asset. But since the only way to do that is to sell the stock, you must also consider the implications of capital gains taxes.

It will be important to consult with your tax and investment advisors about the most efficient tax strategies for unwinding the position. For those with ample assets, it may even make sense to consider establishing a charitable remainder trust to accept the shares. With the help of a qualified estate planning professional, the trust could be structured to provide income during the donor’s lifetime, alleviating the necessity of paying taxes on the sale proceeds. In cases where company stock is held inside a 401(k), one might consider a net unrealized appreciation (NUA) approach. This allows the owner to roll over the shares to a taxable account, at which time they recognize and pay taxes on the owner’s cost basis (calculated on the strike price). If they hold the shares in the account for at least a year before selling them, they would be responsible only for the gain between the time of the rollover and the time of the sale. Further, this gain would qualify for more favorable long-term capital gains treatment. For some individuals, dealing with the tax implications of their stock holding in this way could be more advantageous than simply rolling the shares into a traditional IRA, which would require paying taxes on the entire amount of appreciation all at once, when shares are liquidated to meet RMD rules.

No matter which career phase you may be in, getting the right kind of advice is crucial. At Aspen Wealth Management, our fiduciary duty obligates us to consider each client’s circumstances as a whole before we make any recommendation. This is the only way we can help our clients develop plans that are as unique as they are. To learn more, visit our website to read our article, “What Is Asset Allocation?

Get in touch

Have a question?


    Need a second opinion on your portfolio?
    Get your free financial consultation today: