More and more employee compensation plans include stock options. Options are a cost effective way for a company to share its success with employees, to recruit, motivate, and retain top-notch employees. The downside for the employee, is that options are difficult to understand and plan with. Typical questions one should ask include:
| what are my options likely to be worth? |
| how are my options taxed? |
| what type of options do I have (non-qualified? qualified/statutory/incentive/ISO) |
| when should I exercise my options? should I exercise them before an IPO? should I exercise them before they have vested? (yes you can do this and its sometimes a good idea) |
| how should I ensure proper diversification while still retaining significant upside |
Our belief is that you can understand the way options works and how to go about making intelligent decisions -- if you want to and if you put in the time and effort to learn about how they work. The resources listed here and the talk given by Jon Rochlis at LISA 2000 are intended to help you come up to speed. Either so you can work out your own strategies or be better able to evaluate the skills and knowledge of a financial or tax advisor. Please note: nothing on this pages should be taken as specific advice related to your personal situation. Rather we only discuss the way options, investing, and taxation work. How they general rules apply to your situation is often complex. Consult your personal advisor before taking action.
Slides for Jon's LISA 2000 talk are available. Lisa2000.pdf
There are a few books which describe the ins and outs of employee stock options. More and more seem to be coming out every day! Which are useful and which should you stay away from?
Consider
Your Options: Get the Most from Your Equity Compensation, 2005 Edition by Kaye A.
Thomas.This is where I'd recommend starting. Kaye Thomas does an excellent job at describing the complex landscape of employee stock options. Despite a difficult and tedious subject Consider Your Options is quite well organized, readable, and comprehensive. The authors run a very good web site devoted to the subject (www.fairmark.com). The site consists mostly excerpts from the book plus discussion groups, frequently answered by the authors.
What Consider Your Options lacks, however, is a set of illustrative examples, or detailed discussions of strategies and how they might relative to your own personal situation. Think of it as a excellent description of the rules of the game and a great place to start.
Stock
Options: An Authoritative Guide to Incentive and Nonqualified Stock Options (2nd
edition) by Robert R. PastoreRobert Pastore's thin but expensive book is excellent as well. But it is much harder to absorb. The organization and formatting make it difficult to get through. Unlike Consider Your Options, Pastore's book, isn't polished. But make no mistake about it Pastore knows his stuff and the data is all in here -- including primary source IRS rulings and details relating to insider restrictions.
If you're a techie you'll like his graphical description of option taxation. It helps make all of the text about qualified vs. non-qualified options, bargain element taxation, basis, and Alternative Minimum Tax comprehensible.
This is the book to go for if you want to really get into it. But be careful not to get lost.
Pastore spends a significant amount of time walking through several case studies. This is, perhaps, the best part of the book. Not only do they help to explain the technical details, but they also serve to give one a framework to approach an analysis of what to do. The differential cash flow Internal Rate of Return analysis comparing Buy & Sell with Buy & Hold is excellent but quite involved. Read it several times and take it to heart.
We will add other books over time. In particular I have received requests for pointers to books which address the company point of view more than the employees. If you would like to be notified when we add more reviews or pointers send email.
For now, the box bellow contains Amazon's automatic take on what employee stock option books might be interesting:Use the search function below to see a list of all the books Amazon has relating to Stock Options. Note that this will match books from the company point of view (e.g. how to set up option plans) especially on the (mostly) unrelated topic of playing the stock market with puts, calls, and the like. Feel free to type in another string, and search on that - title, ISBN, author name, etc. should all work, too.
This is the actual tax code defining Incentive Stock Options (ISO) from www.findlaw.com: Laws: Cases and Codes : U.S. Code : Title 26 : Section 422. Remember this is only one portion of the tax code and you should not draw legal conclusions based on a layman's reading of a such a small portion. Yet you can see how understandable this section is. (Don't believe all code sections are similar).
(a) In general
Section 421(a) shall apply with respect to the transfer of a
share of stock to an individual pursuant to his exercise of an
incentive stock option if -
(1) no disposition of such share is made by him within 2 years
from the date of the granting of the option nor within 1 year
after the transfer of such share to him, and
(2) at all times during the period beginning on the date of the
granting of the option and ending on the day 3 months before the
date of such exercise, such individual was an employee of either
the corporation granting such option, a parent or subsidiary
corporation of such corporation, or a corporation or a parent or
subsidiary corporation of such corporation issuing or assuming a
stock option in a transaction to which section 424(a) applies.
(b) Incentive stock option
For purposes of this part, the term ''incentive stock option''
means an option granted to an individual for any reason connected
with his employment by a corporation, if granted by the employer
corporation or its parent or subsidiary corporation, to purchase
stock of any of such corporations, but only if -
(1) the option is granted pursuant to a plan which includes the
aggregate number of shares which may be issued under options and
the employees (or class of employees) eligible to receive
options, and which is approved by the stockholders of the
granting corporation within 12 months before or after the date
such plan is adopted;
(2) such option is granted within 10 years from the date such
plan is adopted, or the date such plan is approved by the
stockholders, whichever is earlier;
(3) such option by its terms is not exercisable after the
expiration of 10 years from the date such option is granted;
(4) the option price is not less than the fair market value of
the stock at the time such option is granted;
(5) such option by its terms is not transferable by such
individual otherwise than by will or the laws of descent and
distribution, and is exercisable, during his lifetime, only by
him; and
(6) such individual, at the time the option is granted, does
not own stock possessing more than 10 percent of the total
combined voting power of all classes of stock of the employer
corporation or of its parent or subsidiary corporation.
Such term shall not include any option if (as of the time the
option is granted) the terms of such option provide that it will
not be treated as an incentive stock option.
(c) Special rules
(1) Good faith efforts to value of stock
If a share of stock is transferred pursuant to the exercise by
an individual of an option which would fail to qualify as an
incentive stock option under subsection (b) because there was a
failure in an attempt, made in good faith, to meet the
requirement of subsection (b)(4), the requirement of subsection
(b)(4) shall be considered to have been met. To the extent
provided in regulations by the Secretary, a similar rule shall
apply for purposes of subsection (d).
(2) Certain disqualifying dispositions where amount realized is
less than value at exercise
If -
(A) an individual who has acquired a share of stock by the
exercise of an incentive stock option makes a disposition of
such share within either of the periods described in subsection
(a)(1), and
(B) such disposition is a sale or exchange with respect to
which a loss (if sustained) would be recognized to such
individual,
then the amount which is includible in the gross income of such
individual, and the amount which is deductible from the income of
his employer corporation, as compensation attributable to the
exercise of such option shall not exceed the excess (if any) of
the amount realized on such sale or exchange over the adjusted
basis of such share.
(3) Certain transfers by insolvent individuals
If an insolvent individual holds a share of stock acquired
pursuant to his exercise of an incentive stock option, and if
such share is transferred to a trustee, receiver, or other
similar fiduciary in any proceeding under title 11 or any other
similar insolvency proceeding, neither such transfer, nor any
other transfer of such share for the benefit of his creditors in
such proceeding, shall constitute a disposition of such share for
purposes of subsection (a)(1).
(4) Permissible provisions
An option which meets the requirements of subsection (b) shall
be treated as an incentive stock option even if -
(A) the employee may pay for the stock with stock of the
corporation granting the option,
(B) the employee has a right to receive property at the time
of exercise of the option, or
(C) the option is subject to any condition not inconsistent
with the provisions of subsection (b).
Subparagraph (B) shall apply to a transfer of property (other
than cash) only if section 83 applies to the property so
transferred.
(5) 10-percent shareholder rule
Subsection (b)(6) shall not apply if at the time such option is
granted the option price is at least 110 percent of the fair
market value of the stock subject to the option and such option
by its terms is not exercisable after the expiration of 5 years
from the date such option is granted.
(6) Special rule when disabled
For purposes of subsection (a)(2), in the case of an employee
who is disabled (within the meaning of section 22(e)(3)), the
3-month period of subsection (a)(2) shall be 1 year.
(7) Fair market value
For purposes of this section, the fair market value of stock
shall be determined without regard to any restriction other than
a restriction which, by its terms, will never lapse.
(d) $100,000 per year limitation
(1) In general
To the extent that the aggregate fair market value of stock
with respect to which incentive stock options (determined without
regard to this subsection) are exercisable for the 1st time by
any individual during any calendar year (under all plans of the
individual's employer corporation and its parent and subsidiary
corporations) exceeds $100,000, such options shall be treated as
options which are not incentive stock options.
(2) Ordering rule
Paragraph (1) shall be applied by taking options into account
in the order in which they were granted.
(3) Determination of fair market value
For purposes of paragraph (1), the fair market value of any
stock shall be determined as of the time the option with respect
to such stock is granted.
The people who wrote Consider Your Options have a very good web site. It has many excerpts from the book plus discussion groups, frequently answered by the authors.
Send mail to
with questions or comments about this web site.
Copyright © 2000 The Rochlis Group, Inc.
Last modified: 09 December 2000
except for minor non-substantive changes on 09 November 2005