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hello and thank you for tuning in today we will be focusing on employee stock options this presentation is brought to you by the California Society of CPAs my name is Darrell young and I'm a volunteer board member and the chair of the financial literacy committee for the peninsula Silicon Valley Chapter of Cal CPA I operate a wealth management practice in the San Francisco Bay Area we intend for this presentation to be interesting and informative the data points contained herein are believed to be current please note however that this presentation is intended to convey general information which may not be applicable to your personal situation please do not interpret the information here as advice for your personal circumstances you should consult with your personal advisor or certainly feel free to give my office a call now as already mentioned today's agenda will focus on employee stock options there's a lot of material to cover in a fairly short amount of time please understand that certainly not going to make you an expert in the subject matter but we do hope to touch upon the high points of employee stock options you see there our agenda on the left-hand side we're going to look at terminology different types of stock options for the purposes of this presentation we're going to focus on non-qualified stock options or non-statutory will look at vesting expiration we will look at sample transaction but before we do all that led to review with you what we believe to be the cornerstones for financial success those being planning in accordance with your goals and your risk factors giving back to your community working with people whom you respect and trust and maintaining a positive attitude and competitive awareness at all times it is our belief that if you are maintaining these behaviors that you have the makings for financial success time is our most precious resource there are no shortcuts to financial success so what exactly is an employee stock option and again we're focusing for the purposes of this presentation on the non-qualified version of stock options there at the bottom you see the definition it allows an employee or an option e to purchase a specified number of shares within a specified period of time at a specified price and that has all determined in the award grant just as a side note in our u.s. population it's estimated that about 9 million employees participate in these types of award arrangements with some background I'd say that stock options have been around for decades had been traditionally awarded to top management and in more modern days you may see that stock options are not just awarded to top executives but also to employees and even sometimes do contractors needless to say they are awarded as a form of compensation and ideally would align the interests of the employee with the company and other shareholders some terminology that you may have come across before strike price or option price is the price at which the employee can purchase the stock or the shares the word exercise itself is a just a fancy word for purchase and we're going to focus on exercising and selling because in my experience ninety percent of the time that is what employees do and we're going to take a look at an example of that expiration date of course is the last day that action can be taken and the spread or they gain is the difference between the fair market value of the stock and the strike price or the option price a few brief notes on administration typically stock options need to be formally accepted as part of a compensation contract so think of it like any other contract that needs to be signed and countersigned by both sides usually a brokerage account must be set up in order for you to be able to transact and in this case ideally to be able to sell shares from options that you've exercised stock options are typically non-transferable so say for example if you are an employee at a company and you're awarded stock options you couldn't for example transfer those stock options to your spouse or to your children again generally they're non transferable termination from the company usually means that you cease vesting at that point although you may be able to exercise any options that are already vested and you'll be given a designated time period to do that types of stock options so again for the purposes of this presentation we're going to be focusing on non-qualified stock options or sometimes non-statutory stock options you see there the reference to the IRS Publication on the left and that particular document provides a wealth of information with respect to all different types of employee compensation stock options just being one type if you have difficulty determining what type of stock option you have obviously it should be stated in your award agreement and that IRS document also provides distinguishing factors in case you need further help in determining which one that you have now in contrast to non-qualified stock options you may have also heard the term incentive stock options I think the key difference there is that instead of stock options offer a little bit of a tax advantage so as you might see there at the time of exercise which again is a fancy word for purchase no ordinary income tax is due and that's assuming that a simultaneous sale of the shares to not occur however note that the alternative minimum tax or the amt may apply how does vesting typically work so of course vesting is the amount of time that needs two laps before the options essentially are seasoned and and the employee can take action on them you see there a couple different methodologies I suppose the most common one is the gradual vesting so in this case example number one you see how the employee has been granted 4,000 options and those options vest one for each year over a four-year stretch and this does not necessarily mean that the employee needs to wait all four years in order to be able to exercise in cell after the first year the employee might be able to go ahead and exercise and sell a thousand options again as they vest typically an expiration date is also attached to the award grant it could be seven years it could be ten years and exactly as the name indicates it is the last date on which the employee can do something with the options be mindful however if your expiration date happens to fall on a weekend or on the holiday because then the actual expiration date would be the prior business day of stock trading trading windows now as an employee of a company who has been awarded options does this mean that you can exercise and sell at any point of time not necessarily perhaps your designated as an insider at the company and in such case perhaps you are subject to blackouts and so you see here as the graph indicates this particular person might only be able to exercise and sell options in trading windows and oftentimes i would say that those trading windows are in conjunction or in association with earnings announcements and other periods where material inside information has has been released to the to the public let's look at an example so again we're looking at non-qualified stock options in my experience I would say that ninety percent of the time this is what you would see an employee exercising again purchasing shares from an option grant and then simultaneously selling those shares on the market to put some numbers to the example let's say that the option price of the strike price was five dollars and the person is able to sell those shares on the open market for 25 exercise and sell date well we're assuming it's going to be februari 20th and the quantity of shares in this case thousand shares and because it's a cell transaction note that the brokerage firm is levying a five cents per share fee on the transaction so what does that mean on the right hand side notice that we have a calculation for taxes being withheld and again this is a non-qualified option transaction so if we say that the sale price on the date of the exercise and sell is twenty-five dollars and the option price is five that means that the employees gaining twenty dollars per share and again we're looking at an example of a thousand shares which means that the gain in this case is twenty thousand dollars so if we assume federal taxes at twenty-five percent California State at 9.3 etcetera what you see there is that the total withholding on the transaction is eight thousand five hundred and seventy dollars so down there at the bottom here's the here's the end result if I as the employee sold a thousand shares on the market at $25 per share I took in twenty five thousand dollars gross minus out from that the five thousand dollars which is my option prices my purchase price minus from that as well the 8570 because that is the tax withholding being applied and then minus out fifty dollars because I am taking my thousand shares and selling them and the broker is charging me a fifty dollar commission so the amount that comes net to me is the eleven thousand three hundred and eighty dollars now are you all done with taxes at this point well I would view this in the same way that you've you say for example the w-2 from your company where you've been subject to withholding but you'll true up with Uncle Sam at the end of the year or on the April 15 deadline in other words now instead let's say that this employee had decided to hold the shares instead of sell them so you see here that the facts are virtually identical the only thing that's really missing is the five cents per share commission on the sale because there is no sale the employee in this case is elected to hold the shares the tax withholding is the same and so rather than the employee taking in proceeds the employee is going to pay the five thousand dollars which is the purchase price of the option price is going to also pay the 8570 which is the tax withholding and that is the cost to exercise what does the employee walk away with in the end of this a thousand shares of the stock and the date of the exercise will become the start of the holding period for either capital gains or losses depending on the direction of the stock price from here on out now getting further assistance I know that we've covered a lot what role can your financial advisor play well certainly to the employer to the company financial advisors like myself can help to provide a platform through which stock options can be exercised and sold we also hope to provide educational opportunities to the people who have been granted stock options to the individual employees on a one-on-one level a financial adviser like myself can also help to manage positions provide advice and guidance within the framework of a holistic financial plan so again my role as a financial advisor I can interface on both levels with the company and also with the individual employees for future reference we hope to cover other topics related to what we've covered here so incentive stock options we didn't spend really any time they're restricted stock awards perhaps you've heard the term before stock purchase plans 10 B 5 dash one trading plans and also early exercise elections there's plenty of other ground for us to cover in the arena of employee stock compensation it's a lot more complicated than you might think with that said I'd like to thank you again for your attention my name is Daryl young I hope you found this presentation to be informative and interesting I welcome your comments thank you for listening