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Tax info on Options

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    Tax info on Options

    Posting a forward I recieved by email on Taxing of options.

    The Basics
    To avoid a tax burn, know your (stock) options
    Those stock options that made paper millionaires of dot-commers have
    turned on many of them with a nasty -- and very real -- bite. Here's how
    to collect your own options gains without the pain.
    By Jeff

    In 1999 and into 2000, everybody (except us) was getting rich on stock
    options. This year, yesterday's dot-com millionaires are hemorrhaging
    tax dollars on those same options.

    If the options problem weren't so painful, it might be funny. But, for
    many people, it is very painful.

    Problems can erupt when you exercise your options. The exercise can
    trigger a tax hit whose severity depends on the terms of the option

    For one Cisco Systems engineer, the severity was enormous. He exercised
    incentive stock options to buy 100,000 Cisco shares in March 2000 at 5
    to 10 cents a share. He exercised the options when Cisco was selling at
    around $62 to $63. On paper, he was ahead $7 million, and, under the
    rules of the Alternative Minimum Tax, he was liable for taxes on the
    gain on the day he exercised the options. So, by April 2001, he faced a
    $2.5 million tax bill on the shares under the AMT rules, which are
    designed to ensure everyone pays some tax. Worse, the value of the
    engineer's shares had fallen some 80%.

    Our goal is to help you survive the options quagmire. To do that, you
    must understand the different kinds of options and how options work.
    Then, if you do get some of your compensation in options, you can start
    planning now to limit the tax problem.

    There are two kinds of stock options. Those that have special tax
    benefits are called Incentive Stock Options (ISOs); those that don't,
    Non-Qualified Options (NQOs). Here's a summary of how they're structured
    and the benefits you get:

    Incentive Stock Option features
    Typically granted to: Executives; senior management.

    Option price: Must be granted at a price that at least equals the
    stock's market value at the time of the grant.

    * When granted: None
    * At exercise: None, but the spread between the exercise price and
    the fair-market value may be subject to the alternative minimum tax. The
    logic is tricky, but here it is. Your vulnerability comes into play when
    the exercise price of your options is substantially lower than the fair
    market value of the shares on the day you exercise. If you fall into the
    world of the AMT, the difference between exercise and market price
    becomes taxable. If the spread is really large, the AMT can become very
    expensive very quickly. So, pay very close attention when you get your
    grant and when you exercise the options.
    * After sale of stock: If you hold your shares for more than one
    year after exercise, the entire spread between the sale price and your
    cost is a long-term capital gain subject to the maximum 20% rate.
    (Capital gains rates weren't changed under the tax bill passed May 26.)
    If you don't hold for more than one year, you "disqualify" your ISO
    shares for long-term capital gains treatment. The difference between the
    fair market value at the time of exercise and the sale price is taxed as
    ordinary income. If you sell the shares before December 31, you're not
    subject to AMT treatment.

    Vesting: May be subject to a graduated vesting schedule or cliff vesting
    schedule, according to the terms of the option agreement. A graduated
    schedule vests a percentage of the options each year for up to seven
    years. On a cliff vesting schedule, the options are all vested at once
    after a specified number of years.

    Expiration: Typically 10 years following the grant date. Terms may vary
    from company to company. Companies are required to disclose the terms of
    their incentive option plans to shareholders.

    Planning: Remember that incentive stock options can trigger alternative
    minimum tax treatment. (The AMT still applies despite a modification in
    the new tax bill designed to provide a little relief.) If the value of
    the stock subsequently falls, you may still be subject to the additional
    taxes the AMT can generate. One way to get around the problem is to sell
    your shares by Dec. 31 of the year you exercise your options. Then, your
    tax is only on the gain between exercise price and sale price, and it's
    not subject to the AMT. Whatever you do, check with a tax advisor who
    knows the tax rules on options before making your move. The wrong move
    can be very costly.

    Non-Qualified Stock Option features
    Typically granted to: All employees in a company.

    Option price: May be lower than the value of the stock on the date of
    the grant, making it instantly "in the money."

    * When granted: None
    * At exercise: Ordinary income tax is due on the spread between
    the exercise price and the fair market value of the stock on the date of
    * After sale of stock: In the year of the sale, capital gains
    taxes are due on the difference between your cost basis (the fair market
    value of the stock on the date you exercise your non-qualified option
    and the price at which you sell the stock.) If you sell within one year,
    the gain between the exercise price and the sale price is a short-term
    capital gain.

    Vesting: May be subject to graduated or cliff vesting, under the terms
    of the company's option agreement.

    Expiration: Typically 10 years following the grant date. As with
    incentive option plans, each company has its own rules on options.

    Planning: Remember, your employer reports the gain you realize when you
    exercise your options on your W-2 and withholds income and employment
    taxes on that amount. Typically, you would pay your employer the amount
    of any withholding, along with the exercise cost of your options.

    One other stock plan
    There's one more variation on this theme that I see. It's called the
    junior stock plan. This is how it works:

    Your employer issues special "junior" non-voting common stock that pays
    regular dividends. These shares can be exchanged for regular common
    stock, share for share, at a specified date, if the holder meets certain

    The junior shares are sold to you at a bargain price -- for example, $20
    when the regular common is trading at $30. You pay income taxes on the
    $10 price spread.

    At the end of the term, when the regular common stock is trading at,
    say, $80, you swap your junior shares for the regular common shares.

    On the sale of the regular common stock, you have a tax basis of $30 --
    the $20 paid for the shares, plus the $10 on which you were taxed. You
    then have a gain of $50 per share -- $80 less your $30 basis -- which is
    taxed at the maximum 20% rate.

    Stock options can offer you some great choices and potential for
    accumulating wealth. They are intended to provide an incentive for an
    employee to continue working for a company. They are not intended to let
    you get rich quick.

    If you're lucky enough to receive options, exercise them carefully. The
    choices you make -- if not made wisely -- can cost you plenty. So, think
    before you exercise and make the right choice for you.

    Best Regards
    Nadeem Khan

    Softech Worldwide LLC
    Phone: +1 703-481-1200
    Cell: +1 703 608 0313
    Fax: +1 (703)783-0775
    email:[email protected]
    [email protected]