The clock is running out for year-end decisions that may have a big impact on your equity awards, including restricted stock units or stock options. In this blog commentary, we provide an introduction to the major issues arising with equity compensation at the close of the year.
No One Size Fits All
Like tastes in festive holiday knitwear, year-end financial and tax planning is very specific to the individual. Decisions in year-end financial and tax planning depend on a number of personal factors:
- your financial situation, including the short-term need to sell stock and/or exercise stock options
- whether your decisions should be entirely tax-driven
- what you did earlier in the year
- your outlook for your company's stock price
- multi-year projections for your income
- your ability to spread the recognition of income from certain sources over 2014 and 2015
Be Aware Of Tax Rates, But Don't Obsess About Them
Unless you were already definitely planning to sell company stock or exercise options soon, most experts feel that unease about higher tax rates in your future should not be the only reason for doing so at the end of the year. However, if you are considering option exercises or stock sales at year-end, you should be aware of the thresholds for higher tax rates and may want to consider keeping your income below them, if possible.
| Tax rate | Yearly income threshold in 2014 |
| Top ordinary income rate (39.6%) | Taxable income of $406,750 (single) or $457,600 (joint) |
| Top rate (20%) on long-term capital gains and on qualified dividends | Taxable income of $406,750 (single) or $457,600 (joint) |
| Medicare surtax on investment income (3.8%) | Modified adjusted gross income of $200,000 (single) or $250,000 (joint) |
| Additional Medicare tax on earned income (0.9%) | Earned income of $200,000 (single) or $250,000 (joint) |
| Phaseout of itemized deductions and personal exemptions | Adjusted gross income of $254,200 (single) or $305,050 (joint) |
Year-End Strategies To Consider
Below we present several situations and some strategies that many experts suggest. Of course, you should consult a financial advisor about your individual situation. See also two other FAQs for additional ideas on exercising stock options and on selling company stock at the end of 2014.
1. You are planning to sell the stock at exercise late this year or early next year. You should calculate whether the ordinary income at 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 if the rate for that bracket goes up. 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.
Alert: When you do sell company stock, reporting it on your tax return raises other issues. See the special section Reporting Company Stock Sales, with annotated examples, in the Tax Center.
2. You are over or near the yearly maximum for Social Security. The Social Security wage base for 2014 is $117,000 (it will be $118,500 in 2015). Social Security tax (6.2%) is owed only up to that income ceiling. If your yearly income is already over that threshold, you can exercise nonqualified stock options or stock appreciation rights in December without paying Social Security tax, and therefore you can keep an extra 6.2% of the related income. If you wait until January, your yearly wage base starts at $0, and Social Security tax will again apply up to the new maximum for that year.
3. 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.
Alert: Unlike the tax provisions outlined in the table above, the income thresholds for triggering the Medicare surtax and the Additional Medicare Tax are not indexed for inflation. The amounts will persist unless Congress changes them.
If your multi-year projections of income show that you will trigger this surtax next year, and if 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 in 2014 rather than in 2015. Additionally, if you exercised incentive stock options during the year, are holding the ISO stock, and have plans to sell the shares after one year, you may want to evaluate the impact of higher capital gains rates, along with the Medicare surtax on investment income. This may lead you to lower taxes by selling the shares in 2014.
Many More Year-End Ideas And Strategies
For eight more ideas on year-end planning with equity compensation, see our flagship year-end FAQ, along with all of the articles and FAQs in our section Financial Planning: Year-End.
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