Option exercise term,
VC Spotlight March 1, From time to time an employer may consider changing the terms of a stock option granted to an employee. This article explores the option exercise term impact of one such change in greater depth, namely, the extension of the exercise period of a stock option.
A corporation extending a stock option outside of these two situations must tread with care, however, as such an extension may option exercise term adverse tax consequences to the employee, as described below.
What is the exercise option exercise term of the option? What is the fair market value FMV of the underlying stock at the time of extension? What is the latest date the option could terminate by its original terms?
Option grants typically provide that the employee may exercise the option any time to the extent vested before the 10th anniversary of the grant 2 of the option, unless, before such 10th anniversary, the employee separates from service, or she dies or becomes disabled. Many plans provide, in the case of separation, death or disability, that the employee or her estate or conservator must exercise within three months to a year of the date of such event or the option terminates.
- Employee stock options ESOs are a type of equity compensation granted by companies to their employees and executives.
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- Sample contract with option
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The situations in which an extension is contemplated vary. For example, an employer might desire to give a terminating employee or her estate or conservator more time option exercise term obtain the funds to pay the exercise price or an opportunity to exercise all or a portion of the option in a later year in order to spread out or lower tax liability.
A longer exercise period might also enable the employee to exercise in conjunction with a sale, IPO or other liquidity event of the corporation which is anticipated to occur after the end of the original exercise period. In most cases, the employer desires to extend the exercise period rather than grant a new option in an attempt to preserve a low original exercise price. In each case, the employer may consider an extension the right thing to do or a concession to keep the departing employee happy.
option exercise term
Employee Stock Option (ESO)
Whatever the reason, the answers to the questions posed above will determine whether the corporation can extend the option without creating a tax problem for the employee.
If the extended ISO fails ISO characterization upon reevaluation which will be the case if the stock has appreciated since original grantit will be treated as a NQO from the date of original grant.
Why is this determination important? One reason is expectations.
The employee might expect to continue to have favorable ISO tax treatment after the extension. By comparison, if an option is treated as a NQO, the employee will have income equal to the difference between the exercise price and the fair market value of the stock typically upon exercise. Upon the later sale of the stock, assuming she holds the stock for more than one year, any additional gain will be subject to the lower capital gains rates.
If the option is re-characterized as a NQO, it must also be analyzed under Section A, a complex set of tax rules which may cause adverse tax consequences to the employee in certain situations. What is an Employer To Do?
There are important exceptions to the unfavorable treatment of NQO extensions. These are handy exceptions which can provide the employer and employee with the flexibility needed to achieve their goals.
Taking advantage of these exceptions requires knowing the answers to Questions above regarding, the original exercise price, the new FMV and the original term of the option. If option exercise term exceptions do not apply, there is limited relief when an extension causes an option to be subject to adverse tax consequences under Section A.
When can I exercise my stock options? The process of earning the right to exercise is called vesting. You can usually only exercise vested stock options. Some companies will allow you to early exercise before your options vest.
Fast action is required as the employer must rescind the extension by the earlier of the date the stock right is exercised or the last day of the year in which the employer extended the option. Conclusion Changes to option terms, including the extension of the option exercise period, raise important tax issues.
- Roger Wohlner is a financial advisor and writer with 20 years of experience in the industry.
- Styles[ edit ] The option style, as specified in the contract, determines when, how, and under what circumstances, the option holder may exercise it.
- Exercise means to put into effect the right to buy or sell the underlying financial instrument specified in an options contract.
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While alternatives for extension exist that do not result in adverse tax consequences to the employee, an employer considering an extension should seek advice of tax counsel before making such a change. For further information on this topic, please contact a member of our Tax Practice Group.
Discussion of these terms is beyond the scope of this article.