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Answer:
Dear
BuyandHolder,
You're
absolutely right. Microsoft has abandoned stock option-based
pay packages and is now giving employees restricted
stock. I expect that other companies will follow
the Microsoft example, so it pays to know the good
and the bad about this type of compensation.
Stock
Options...
First,
let's review stock options. In general, they're most
valuable for those working at a fast-growing company.
Stock options give you the right to buy your company's
stock some time in the future and at a predetermined,
set price. Stock options are usually priced at fair
market value at the time of the grant.
If
the stock rises, you come out a winner. On the other
hand, if the stock falls below the preset price, your
options are worthless.
For
example, let's say a company's stock sells at $10
and an employee is given 400 options to buy the shares
any time over the next 10 years at $10/share. If the
stock goes up to $30/share, the employee could exercise
the options and purchase the stock at $10/share, turn
around and sell it at $30/shares. He would pocket
$8,000 (400 shares times the $20/share profit).
If
the stock falls below $10/share, the options will
expire worthless.
Restricted
Stock...
A
restricted stock is an outright gift of company shares
and it's always worth something, unless the company
declares bankruptcy. Companies tend to give employees
fewer shares of restricted stock than stock options.
The typical ratio is one restricted share for every
three or four options.
If
the company's stock is selling at $10/share, each
share granted to an employee is worth $10/share on
the date it vests.
You
do, however, have to meet the vesting requirement
-- that you've worked for the company for a certain
number of years. The time requirement varies, but
more often than not it is four years. Once the stock
is vested, it then becomes yours -- at no cost.
Restricted
stock shares move up and down in price right along
with the company's common shares. But, even if the
stock drops in price after the "grant," you still
have what it's worth.
The
Tax Issue...
Stock
options generally are not taxed until you exercise
them. This gives you some degree of control over when
you'll be hit with a tax bill.
Shares
of restricted stock, on the other hand are taxed in
the year that they vest. The company, not you, determines
when that will be.
Not
only will you be taxed whether or not you sell your
shares, you'll be taxed at your ordinary income tax
rate -- which could be as high as 35 cents on the
dollar. The reason? The IRS considers restricted stock
a type of compensation.
Anyone
with a restricted stock plan should talk with their
accountant about the wisdom of making a Section
83(b). Doing so requires you to pay taxes within
30 days of receiving the grant...in other words you
pay income tax based on the value of the stock at
the time of the grant. But the tradeoff is that any
future gains will be taxed at the lower capital gains
rate. This strategy is a real plus if the stock
goes up between the date of the grant and the date
of vesting. (Not all restricted stock plans offer
the Section 83(b) strategy.)
Caution:
If you leave your job before the shares vest and you've
opted for a Section 83(b), you will wind up paying
taxes on income you never received. And, if the stock
declines in price, you'll be out your overpayment.
About
Dividends...
A
restricted stock may pay dividends. If so, you'll
received dividend payments even if the shares have
not vested. The dividends, of course, are considered
as income, so you'll pay taxes on them -- again at
your ordinary income tax rate, not the lower capital
gains rate.
However,
the good news is that once your shares vest, dividends
will be taxed at the new lower rate.
If
you opt for the 83(b) election, you'll be paying the
lower rate on dividends from the get go.
About
Selling...
If
you decide to keep the stock after it's vested for
at least a year and then sell it, you will be taxed
at the lower capital gains rate.
More
Information...
For
details about the new tax rules pertaining to dividends
and capital gains, read a previous column on the topic.
Click HERE.
Continually
updated material on both stock options and restricted
shares is posted at www.MyStockOptions.com.
BUYandHOLD
does not recommend any securities. The security mentioned
above is being used for illustrative and informational
purposes only and should not be regarded as an offer
to sell or as a solicitation of an offer to buy.
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