How will incentive and non-qualified stock options affect an estate?

August 14, 1999

Subject:   Erosion of Stock Values to Estate Upon Death
From:   Tim

Hi Michael,

I greatly enjoy your website and have referred to it a few times while counseling my clients who hold significant ISO’s & NSO’s. One of the other CFP’s in our office and I are having a discussion regarding a case we are working on. Let me run the scenario by you for your comments:

Using round numbers, Client Jones, a single, divorced male, is currently vested in options, both ISO and NSO, with a pre-tax value of $12,000,000. He has a life insurance policy, inside of his estate, with a face value of $575,000. He owns, within his RLT, @ $2,000,000 of assets, net (home, etc.).

Assuming he dies today, this is how we see the income and estate tax scenarios playing out.

Gross Estate: $14,575,000.
Estate Tax Due: ($ 7,500,000)
Income Tax Due: ($ 5,500,000)
Add Credits from 706: $3,000,000
Net Estate: $4,575,000

Does this seem roughly accurate? An @70% net shrinkage due to income and estate taxes?

If so, this is much worse than the effect of a large IRA inside of the estate! Also, if true, this points to the very real need for people to put together a strategy to exercise these options regularly and consistently!

What do you advise clients with this type of scenario?

Thanks for your insights,



Hello Tim,

Thanks for writing.

When you have an estate tax rate of 55%, it shouldn’t be surprising to see a shrinkage after income taxes of 70%. It may well be greater. Your “credits from 706” looks overstated.

One thing you haven’t considered is that the income tax rate could be lower for ISOs if the holding period requirements are met.

Since the income from both IRAs and from NQOs is ordinary income, the tax results are similar.

One “remedy” that is similar for both retirement accounts and for NQOs is to leave them to a charity. For retirement accounts, the way to do this is by naming the charity as a beneficiary. For NQOs, the way to do it is by making a specific bequest of the NQOs to a charity.

The IRS recently issued Letter Ruling 200012076, concluding that when a charity exercises NQOs received as a specific bequest, the income with respect of a decedent flows to the charity (to which it will be tax exempt income) and not to the decedent’s estate or to the other beneficiaries of the decedent.

If the client is charitably inclined anyway, these “tax loaded” assets are the ideal candidates to give.

I “cash flow” these figures with clients and discuss whether they should get additional life insurance to provide for their families’ needs.

About 99% of the people I see who have stock options don’t have a will, so I emphasize the importance of getting an estate plan in place and give them referrals for some good attorneys that I work with.

Some people aren’t very concerned, because the estate tax isn’t really “their” tax problem, it’s someone else’s.

Good luck!

Mike Gray

For more information about incentive stock options, request our free report, Incentive Stock Options – Executive Tax and Financial Planning Strategies.

For more information about non-qualified stock options, request our free report Non-Qualified Stock Options – Executive Tax and Financial Planning Strategies.

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