Stock Options

How to avoid tax when converting to shares and
accessing gains!

For those lucky enough to receive stock options from their employers there is always the question of how and when these valuable assets should be exercised.

Usually stock options are given to senior executives and may be exercised within a time framework, usually ten years. There is a vesting period, often the first two years from outset when these options cannot be exercised. Thereafter it's a question of waiting until they are "in profit" (above the option price given at outset).

Whilst these options remain "just options" (giving the right to buy at a predetermined price at outset) they have no tradable exact value. However, as the underlying share rises in value the option, if exercised, can have a very considerable value. For example, if the option price is $50 and the current share value was $100, the potential profit is $50. However if the share price reduced by 50% back to $50, then 100% of the profit is lost. This effect is called gearing, in this case 2:1. Thus 50% reduction or increase in share value means a 100% gain or loss of profit.

As the share price increases (increasing profit in the option) the effective gearing increases and therefore this is a further worry for option holders. The first rule of owning share options is always "continue to exercise these options, taking profits or converting to 'real shares' as related share prices rise".

Once an option is converted to a share then there is no gearing and no restriction of time (options granted for 10 years only). The second rule is never wait until the end of the 10 year option period to exercise shares that are "in profit". At the term end there is no flexibility in awaiting a good price. At term end you must take the price prevailing at that time.

All that said, there is a downside to exercising share options. Firstly you have to buy the options, requiring cash, or "exercise and sell", causing a tax chargeable event. A nice problem to have you might say! But never the less, most execs will be higher rate tax payers and that could mean a 40% + tax bill on profits (dependant on your nationality and residency).

So is there an answer to these dilemmas? The answer is, "we believe so".

By careful use of offshore wrappers, option purchase and transfers, we have succeeded in avoiding taxes on our clients share options when exercised. We are also able to fund the purchase of shares from "options" using existing clients investment portfolio's as security.

So profits stay intact, advance planning is a must in these and other investment asset accumulation. Contact us at KMI to receive personal advice on your particular circumstances. Meanwhile, happy investing...