7 Ideas For Year-End Planning With Stock Options And Restricted Stock

Along with Christmas trees, Santa hats, and office holiday parties, year-end is also a key time for financial and tax planning, especially for the millions of employees and executives who have stock compensation, participate in an employee stock purchase plan (ESPP), or hold company shares. Tax changes introduced in 2018 by the Tax Cuts & Jobs Act (tax reform) continue to affect year-end-planning decisions. Meanwhile, the election year ahead in 2020 presents uncertainty about the future of tax laws that affect financial- and tax-planning strategies.

Factors that impact your decisions in year-end planning include:

• your situation, including cash needs that may prompt option exercises and/or stock sales
• whether your decisions should be entirely tax-driven
• what you did earlier in the year with your outstanding stock grant
• whether you will owe additional taxes beyond what was withheld
• your outlook for both your company’s stock price and your job
• multi-year projections for your income
• your ability to spread the recognition of income from certain sources over this year and next
• stock options that may expire soon
• grants of stock options and/or restricted stock you expect in the year ahead
• availability of an ESPP and the share purchase dates
• stock trading windows and blackouts and/or ownership guidelines imposed by your company

Should Tax Rates Drive Decisions?

Consider the income tax rates and income ranges that fall within each tax bracket for this year and next. With year-end planning, you are looking for ways to shift income between years so that you are paying less in tax, while also considering the outlook for your company’s stock.

If you are considering option exercises or stock sales at year-end, you should be aware of the thresholds for higher tax rates and consider keeping your income below them, if possible. In general, financial advisors suggest that investment objectives, expectations for stock-price performance, and personal financial needs—along with tax considerations—should drive your decisions.

7 Strategies

Below are seven strategies suggested from the many ideas in the year-end planning section of myStockOptions.com, a website with educational content and tools on all types of equity compensation.

1. You are planning to sell the stock at exercise late this year or early next year. You should calculate whether the ordinary income from a nonqualified stock option exercise will push you into a higher tax bracket and/or trigger the Medicare surtax on your investment gains, and what the taxes will be when the rates and bracket thresholds are adjusted for inflation in 2020. To break up the tax hit from an income spike, you may want to spread the same-day exercise/sale over the end of this year and the beginning of next year. Plus, you’ll want to defer exercising into 2020 if you are confident your personal tax rate for the income triggered will be lower.

2. You are over or near the yearly maximum for Social Security. The Social Security wage base for 2019 is $132,900 ($137,700 in 2020). Social Security tax (6.2%) is owed only up to that income ceiling (Medicare tax is uncapped).

• Yearly income already over that threshold: Exercise nonqualified stock options or stock appreciation rights in December without paying Social Security tax so that you can keep an extra 6.2% of the related income.
• If you wait until January, your yearly wage base restarts at $0, and Social Security tax will again apply up to the new maximum for that year.

3. You expect next year to trigger the additional Medicare tax. The Medicare tax rate (normally 1.45%) is 2.35% for single filers with yearly compensation income of more than $200,000 (more than $250,000 for married joint filers). In addition, a 3.8% Medicare surtax applies to investment income, such as dividends and stock sale gains, for people in that same income range.

Example: Your multi-year projections of income show that you will trigger this surtax next year. You have company stock or other investments that you intend to sell soon, you may want to avoid the additional 3.8% tax by selling this year instead of next year.

4. Your restricted stock or restricted stock units (RSUs) vested this year. Unlike stock options, which trigger taxes when you choose to exercise them, restricted stock and RSUs usually give you no control over the timing of your taxes because you are taxed when the shares vest. The two exceptions to this are rare: opting to be taxed at grant instead by making a Section 83(b) election, which is unavailable for RSUs, or having RSUs with deferral features.

At vesting, you own the stock outright and have taxable W-2 income. Therefore, you can try to plan the timing and shifting of other income around this restricted stock/RSU income, as suggested in #1 above. See also the considerations in #6 about whether to continue holding the stock after vesting, which are similar to the question of whether to hold NQSOs exercised this year.

5. You exercised incentive stock options (ISOs) this year, you still hold the stock, and the stock price dropped substantially. While the changes in the AMT calculation under the TCJA make it much less likely you’ll trigger the AMT, it is still important to calculate whether you should sell the stock this year (i.e. a disqualifying disposition) to eliminate any alternative minimum tax on the spread at exercise. Not doing this “escape hatch” analysis near the end of the year, especially if your company’s stock price fell after an exercise earlier in the year, is a big mistake that many people with ISOs make. Should you decide to sell the stock, to avoid problems with the wash sale rule do not repurchase company shares within 30 days after the sale.

6. The stock price rose (or fell) after your exercise of nonqualified stock options (NQSOs) or your restricted stock/RSU vesting this year. The tax treatment is fixed at the time you exercise options or stock appreciation rights, and at the vesting of RSUs or restricted stock (assuming no Section 83(b) election for restricted stock). This is the tax rule for your federal and state income tax, regardless of the future stock price and whether you hold or sell the stock. You may have planned to sell the stock at price targets after holding it long enough to receive long-term capital gains treatment, but the stock price fell significantly. Therefore, you may want to consider selling the stock to receive a short-term capital loss, perhaps to net the loss against any capital gain, to diversify, or at least to cover any additional taxes that you will owe with your tax return for the spread at exercise or the value at vesting.

Alert: When you sell company stock at a loss to net against gains, be careful about the wash sale rule if you intend to buy the same stock again soon (see my Forbes.com blog piece Year-End Stock Sales To Harvest Capital Losses: Beware Wash Sales). You should wait at least 30 days before repurchasing. However, you can sell appreciated stock for a gain and soon repurchase it without wash sale problems.

Alternatively, your stock price may have substantially increased, hitting your targets earlier than you expected. You may want to sell before the one-year mark because you are concerned that your stock has peaked or that tax rates will rise, or because you are worried about overconcentration in company stock. However, you may not want to pay short-term capital gains rates (i.e. the same rates as those for ordinary income). Check whether you have capital-loss carry-forwards from last year or short-term losses from this year that you can net against these gains. This is a good time to use up these losses against your short-term gains, which can also be created from sales of ESPP shares.

7. You want to donate stock or cash. The end of the year is also a time when many people consider making gifts and donations of company stock. This can be made directly with company stock to a charity or through a foundation or donor-advised fund.

The increase in the standard deduction under tax reform can make donations worth more when you’re trying to still itemize deductions. Look at your prior year’s Form 1040 tax return on Schedule A to see if you are able to itemize or could if you bunch together donations this year to get over the standard deduction amount ($12,200 for individuals and $24,400 for joint filers in 2019). As I have explained before in this blog, once you understand the tax rules, stock donations are often a better approach for appreciated shares held more than one year than first selling them and then donating the cash.

Be sure the stock transfer is completed by December 31 to make it count for the current tax year. For electronic transfers from your brokerage account, the donation is recorded on the day it is received by the charity/foundation (not when you approve the transfer). With increased year-end activity at brokerage firms and charities, plan year-end stock gifts early and have ongoing communications with your broker to ensure the transfer takes place. Donations of private and pre-IPO company stock can take even longer with more documents to complete.