Subject:   Exchanged Non-qualified Performance Stock Plan to non-qualified Stock Options
Date:   Tue, 24 Apr 2001
From:   Jerrie

I have been given a non-qualified performance stock plan which will mature in 5 years. I have recently received a letter from our legal department indicating that they want to exchange my current non-qualified performance stock plan for equal shares of non-qualified stock options.

They explained the reason for doing this is that Performance Stock Options may subject both the company and me, the employee, to adverse tax treatment such as recognizing the performance stock as income in the year granted rather than the year received.

Can you explain the pros and cons of agreeing or not agreeing to this trade? What will I gain or lose, if anything? Thank you in advance for any advice you give.

Jerrie

Answer

Date:   10 May 2001

Hello Jerrie,

Thanks for writing.

From what I gather, you are exchanging a stock grant plan for a stock option plan.

When you receive a stock grant, you are taxed on the fair market value of the stock received. If vesting applies, you will be taxed on the fair market value of the stock as it vests.

When you receive a non-qualified stock option, generally you are taxed based on the excess of the fair market value of the stock received over the option price when the option is exercised.

The advantage of the stock option is you postpone the tax until you exercise the option. In addition, you participate in the growth of the company without investing any capital until you exercise the option.

The disadvantage of a stock option is you may pay a high tax if the stock really appreciates. The tax at exercise is additional compensation, taxed at your marginal (highest) tax rate. You would probably sell the stock to have the money to pay the tax.

You can get in about the same position as the stock grant by exercising your option as soon as possible. Then you have to deal with the market risk of holding the stock.

There is no “right” answer for everyone.

Good luck!

Mike Gray

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