Get The Most Out Of Employee Stock Options

Employers engaged in a trade or business who pay compensation.

Help Menu Mobile

Employers need to be cautious about discussing an affiliated corporation's stock option plan with employees, during both the hiring process and the employment relationship.

If it is subsequently determined that the nongranting employer also promised the employee that he could participate in the stock option program, and the terms of the stock option are not satisfied, the employee may be able to make a claim against the employer that includes monetary damages.

In the Federal Labor Court's decision of May 28, , there was no dispute that the employer—without the parent corporation's involvement—had promised to obtain the stock options for the employee for a certain price, even though the options concerned stock in the parent corporation. The dispute before the court was not whether the employer had agreed to become involved with the parent corporation's stock option program but whether this obligation ceased to exist once the employment relationship ended.

Stock option plans often include a clause that requires a certain connection by the employee to the employer through a specific date. If this condition is not satisfied— e. The Federal Labor Court has explicitly held that case law concerning benefits, as it has evolved over the years, particularly in relation to bonus payments, is not to be applied on its face to stock option plans. This is because stock options differ fundamentally from conventional benefits, primarily with respect to the risks involved.

As has become abundantly clear over the last few months, an employee cannot assume that stock options will retain their value over time, even when both the employee and the company perform well. Factors that neither the employee nor the company can influence may also play a role, e.

In extreme cases, as mentioned by the Federal Labor Court, "the stock options may lose their entire value within the course of one day. It is for this reason that the Federal Labor Court has permitted relatively long vesting periods before an employee may exercise his stock options. A two-year vesting period for the initial vesting of stock options is expressly required under Germany's Stock Corporation Act as long as it concerns purely the granting of stock options to employees or management.

Conversely, German law does not prescribe a maximum vesting period. Without taking a formal stance on this issue, the Federal Labor Court did say, however, that a vesting period of up to five years is reasonable. Because of the inherent financial risks associated with stock options, the Federal Labor Court agreed that an employee's right to exercise his stock options may lapse once the employment relationship ends.

This is the case not only if the employment relationship ends during the vesting period, but also if the vesting period has already expired. The Federal Labor Court added that it recognizes that this may lead to a financial burden on employees. Regardless, it is not an unreasonable burden, because the employee merely lost an opportunity to reap a financial windfall; he did not take a direct financial hit.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. Your LinkedIn Connections at Firm.

Stock Options as a Financial Risk Stock option plans often include a clause that requires a certain connection by the employee to the employer through a specific date. Do you have a Question or Comment? Interested in the next Webinar on this Topic? Click here to register your Interest. Events from this Firm. More from this Firm. More from this Author.

News About this Firm. New guidance from the UK Advisory, Conciliation and Arbitration Service Acas provides employers with a timely reminder in relation to their obligations when providing and obtaining references The bargain element is calculated by subtracting the exercise price from the market price of the company stock on the date the option is exercised.

The Internal Revenue Code also has a set of rules that an owner must obey to avoid paying hefty taxes on his or her contracts.

The taxation of stock option contracts depends on the type of option owned. Although the timing of a stock option strategy is important, there are other considerations to be made. Another key aspect of stock option planning is the effect that these instruments will have on overall asset allocation.

For any investment plan to be successful, the assets have to be properly diversified. An employee should be wary of concentrated positions on any company's stock.

While you may feel comfortable investing a larger percentage of your portfolio in your own company, it's simply safer to diversify. Conceptually, options are an attractive payment method. In practice, however, redemption and taxation of these instruments can be quite complicated. Most employees do not understand the tax effects of owning and exercising their options. As a result, they can be heavily penalized by Uncle Sam and often miss out on some of the money generated by these contracts.

Remember that selling your employee stock immediately after exercise will induce the higher short-term capital gains tax. Waiting until the sale qualifies for the lesser long-term capital gains tax can save you hundreds, or even thousands.

What's an Employee Stock Option? Grant Date, Expiration, Vesting and Exercise To begin, employees are typically not granted full ownership of the options on the initiation date of the contract, also know as the grant date. Taxing Employee Stock Options The Internal Revenue Code also has a set of rules that an owner must obey to avoid paying hefty taxes on his or her contracts.

For non-qualified stock options NSO: The grant is not a taxable event. Taxation begins at the time of exercise. The bargain element of a non-qualified stock option is considered "compensation" and is taxed at ordinary income tax rates. The sale of the security triggers another taxable event. If the employee decides to sell the shares immediately or less than a year from exercise , the transaction will be reported as a short-term capital gain or loss and will be subject to tax at ordinary income tax rates.

If the employee decides to sell the shares a year after the exercise, the sale will be reported as a long-term capital gain or loss and the tax will be reduced. Incentive stock options ISO receive special tax treatment: The grant is not a taxable transaction.

No taxable events are reported at exercise. However, the bargain element of an incentive stock option may trigger alternative minimum tax AMT.