Optimizing Your Stock-Based Compensation
Good news! You are a well-paid corporate executive with the opportunity to potentially double or triple your annual income through the receipt of shares of company stock as part of your total compensation package. Since your decisions and actions have a direct impact on the increasing value of your company’s stock, you are excited to have your financial future so directly connected to its promising future.
The stock you will receive might be in the form of unrestricted shares that you could hold or sell at your discretion. But this is not usually the case. Instead, their award to you is spread out over time and/or subject to restrictions as to the disposition of awarded shares. For example, you may get shares right away, but they contain a legend on them restricting their disposition. Or, the total number of shares you will receive is contingent upon the company meeting future profitability goals. There may also be a vesting schedule after the number of shares to which you are entitled to receive has been determined.
Opportunities and Challenges
The actual value of your stock awards can be difficult to determine since their value is dependent upon the future event just mentioned. We have seen actual awards range from 50 percent to 200 percent of the base award depending on whether or not the company’s future profitability goals were met. The value per share can also vary widely from when you first are granted the award to when it finally vests.
Once the shares vest, there are additional opportunities and challenges: How much income tax is due? When will it be paid? How can it be minimized? Can the stock now be sold or must it be held for any reason?
When you are given stock in a company, you have to pay taxes on it in the same way you pay taxes on any other income. The amount of tax and when you pay it are determined based on the fair market value of the stock when it is transferred to you.
Strategies and Solutions
Consider making an IRS code section 83(b) election to significantly reduce your tax burden. Normally tax is due when your awarded shares vest. However, through an 83(b) election you choose to be taxed on the entire amount that will eventually vest at the value of the stock at the start of your vesting agreement. This works best when the stock value at the beginning of the vesting schedule is very low and is expected to rise quickly.
Each year’s compensation package can come with another layer of stock awards and grants, each with its own timing, profitability targets and vesting schedule. It is important to keep track of when these vest, the amount that will be included in your taxable income and the amount of tax that will be due.
Standard withholding on stock awards is at a 25 percent rate. But you may find yourself in the 35 percent or higher tax rate when your award is added to your other income. This can result in a big negative surprise when you file your tax return and have a large balance due. Be sure you accurately forecast your estimated tax liability and have the liquidity to pay it so as to avoid any penalty or interest to the IRS.
Sometimes additional shares can be sold for this purpose. But often the stock is retained for future appreciation or due to regulatory restrictions applied to high-level corporate executives, such as blackout periods before the release of quarterly SEC reports. This can result in an overall investment portfolio that contains a very large position in company stock. Care must be taken to diversify the rest of your investments, considering this concentration in company stock, so as not to duplicate the industry or asset class and thereby inadvertently increase the risk of your total portfolio.
We have seen properly managed stock-based compensation rocket our corporate executive clients from living comfortably to true financial independence within a very short period of time. Be sure your wealth plan contains the strategies necessary to optimize your stock- based compensation so it has the same result for you.
Tom Kirk is president, founder and WealthCoach at FirstWave Financial in Satellite Beach, Fla.