A recent report by the New York investment firm of Sanford C. This increased interest in stock options means the charitable gift planner and estate planner need to know the basic ground rules regarding stock options, and how they can be dealt with in charitable gift planning and estate planning.
Stock options are a contractual right given by a corporation to an employee and, sometimes, to an independent contractor to purchase stock in the corporation at a stated price per share for a stated period of time.
There are two basic types of options. Generally, this type of option is not taxable to an employee when granted, unless the option has a readily ascertainable value i. Compensation is realized when the option is exercised or "otherwise disposed of. This is seldom done, however, because of the difficulty in ascertaining the value of those options.
No income will then be realized on their subsequent exercise. This includes incentive stock options ISOs and employee stock purchase plans. An ISO is a compensatory option where the employer grants the employee the right to purchase the employer's stock at some time in the future at a specified price.
An employee stock purchase plan is used by employers as a method for employees to purchase stock of the employer usually using payroll deductions to pay for the shares. These plans grant options to employees to purchase company stock. What the option price is and when the option is granted are variables.
Some employers sponsor offerings to all employees of stock at a certain price, and the employee may accept the offering and receive stock once the offering price is paid. Other plans may provide that an employee's payroll deductions are used to purchase stock at a specified time such as the end of each calendar quarter. Payroll deductions that were not enough to purchase a full share of stock may be carried over into the next purchase period. Among other requirements, the employee optionee will not be taxed upon the grant or exercise of a statutory option provided the option:.
The employee does not recognize taxable compensation income at the time the option is granted or at the time the option is exercised unless exercised more than three months after leaving employment. The price for such avoidance is that the employee must not dispose of the stock until the later of two years from the date the option was granted or one year from the date the employee received the shares upon exercise.
A disposition includes a sale, exchange, or gift. If the employee disposes of the stock before the holding period is up, he must recognize as compensation income the difference between the option exercise price and the fair market value of the stock at the time of the option exercise. In addition, he will recognize income equal to the difference between his basis in the stock the exercise price increased by the amount included in gross income as compensation and the amount he receives in the disposition.
If the employee waits to dispose of the stock until after the holding period, there will be no compensation income, but there will be possible capital gains mid- or long-term, depending on how long the stock is held. The capital gains would be the difference between the amount received in the disposition over the basis in the stock i.
While the exercise of an ISO does not result in current taxable income, there are implications with regard to the AMT. When calculating income for AMT purposes, the difference between the fair market value and the exercise price will be considered part of AMT income. The holding period for capital gains treatment does not begin until the option is exercised. Where does cash for exercise come from?
Generally, a disposition is any sale, exchange, gift or transfer of legal title of the stock. As long as the employee has held the stock for the required holding period - at least two years from the grant of the option, but also more than one year after its exercise - the gift is subject to the same deductibility rules as with any gift of appreciated long-term capital gain property: After the holding period, an employee contributes acquired stock to a charitable remainder trust, and the trust sells stock.
Another option is for the employee to establish a charitable remainder trust with other assets to offset gain in connection with exercise of option. An employee establishes a charitable lead trust with cash proceeds of sale or with other assets to offset gain in connection with exercise of option. An employee transfers stock to charity in exchange for an annuity.
Lifetime gifts are an important element of estate planning. Assets with significant appreciation potential are attractive property for giving. Options often fill the bill in this regard. However, the gift is not completed until employee performs services that are a precondition to exercise of the option. Tax Implications for Option Holder: A transfer by gift is not considered disposition because it is not at arm's-length.
The transferee benefits because the option appreciates without being subject to income tax. Payment of income tax on exercise should not be considered a further gift subject to gift tax. Tax Implications for Transferee: On exercise of option, the transferee gets the cost basis equal to the sum of consideration paid by the transferee on exercise and amount of income realized by the donor. The transferee recognizes capital gains or loss only upon sale of the acquired stock.
The holding period begins on date of exercise. For those employers whose stock is subject to SEC regulations, there are three primary securities law issues that must be considered in the establishment of an plan: Participants will receive information regarding the ISO plan and its operation, although this information does not necessarily have to be a separate document for securities law purposes. Annual proxy statements must disclose the existence and the details of an ISO plan, as well as the stock options granted to or exercised by directors and officers.
The Securities and Exchange Commission amended its rules regarding "short swing profit" liability effective May 1, However, the grant is exempt from "short swing profit" liability if it is pursuant to a written employee benefit plan that is approved by the shareholders and that specified the basis for determining eligibility to participate in the plan, and that either:.
The plan, or a written agreement, with the employee also must provide that derivative securities are not transferable other than by Will or the laws of descent or distribution, or pursuant to a qualified domestic relations order. SEC Rule Stock: Regardless of whether they are publicly traded or not, securities are subject to certain Securities and Exchange Commission rules regarding their sale if they are acquired, directly or indirectly, in a transaction or chain of transactions not involving a public offering in which case they are "restricted securities" from: SEC Rule provides a safe harbor for the sale of these securities if all the conditions of the rule are met.
Generally, Rule requires that a charity and its donor together must hold restricted securities for a minimum of one year before their sale in accordance with the rule. It also imposes a value limitation on the amount of securities that can be sold by affiliates of the company during any three-month period and may require aggregation of the charity's sales with the donor's.
Adequate current information on the issuing corporation must be on file with the SEC. The SEC, as well as the principal national exchange on which the securities are listed, must be notified of the sale.
Securities laws do not generally prohibit giving options, but donor's restrictions on sale do apply to the donee including charity. The rule that a donor receives a fair market value charitable deduction for income tax purposes for gifts of publicly traded stock to a private foundation is now permanent and retroactive to June 30, ESOP is tax qualified, defined contribution employee benefit plan whereby, in return for meeting certain rules that protect the interests of plan participants, the ESOP sponsors receive various tax benefits.
Ordinarily, to set up an ESOP, the company creates a trust fund for employees and funds it by one, or a combination of the following tax deductible methods:. The employer can deduct within limits contributions to an ESOP, including both principal and interest on loan proceeds the ESOP uses to buy company stock.
The donor gets a charitable deduction for the full fair market value and avoids capital gains on the appreciation, or the owner of shares can use the proceeds of the sale to an ESOP to purchase a QRP and then give the QRP to a qualified charity.
The individual owns the QRP with the same holding period and basis as the stock sold to the ESOP, but avoids capital gains and gets the full fair market value deduction by giving QRP to charity or, perhaps, to a qualified charitable remainder trust, retaining an income stream. The following case study, Exhibit A , demonstrates a variety of options when selling stocks.
The discussion includes selling stock in the same year with contributions of cash to a life income trust, charitable lead trust, and gift annuity. Also shown is the sale of stock after 18 months with contributions to a life income trust, charitable lead trust, and gift annuity.
We believe the comparisons speak for themselves. They intend to exercise their options, and then either hold the stock for at least 12 months, or sell it earlier.
For this case study, we will assume the remaining assets generate nontaxable income to this couple. Overall, they seek the following:. It's a timely topic, as shown by recent articles in, for example, The New York Times.
Actual tax may be less because of taxation of gift annuity payments. Assume results in no deduction for State taxes. Join Today For Free! Skip to Main Content Area. Court of Appeals U. Court of Claims U. National Publication last updated: Summary Are your clients exercising all of their charitable options?
Temple and Fred J. Marcus join to explore the rules and opportunities that surround contributions of employee stock options and restricted optioned stock. Published on Jun Among other requirements, the employee optionee will not be taxed upon the grant or exercise of a statutory option provided the option: Brokerage loan and sale.
Sale in same year. Disposition Of Option Stock Generally, a disposition is any sale, exchange, gift or transfer of legal title of the stock. Transfer from a decedent who held ISO stock to an estate, or a transfer by bequest or inheritance. Exchange of ISO stock in certain nonrecognition transactions e. Pledge or hypothecation is not a disposition, but transfer pursuant to pledge or hypothecation is a disposition.
Between spouses incident to a divorce. Acquisition in joint ownership with right of survivorship. Change in joint ownership is disposition. The IRS has ruled that: Purchase of a put on option stock is not a disposition.
Securities Law Restrictions Federal Law: Publicly-Traded Securities and Private Foundations The rule that a donor receives a fair market value charitable deduction for income tax purposes for gifts of publicly traded stock to a private foundation is now permanent and retroactive to June 30,More...