The Tao Of Stock Options: Exercise Strategies From Stock Option Gurus

When we started myStockOptions.com in 2000, stock options were all the rage in equity comp. While other forms of equity compensation have since come to the fore, most notably restricted stock units (RSUs), stock options remain a major form of equity award for millions of employees in the US.

In this spirit, we recently returned to the roots of our trusted brand name in a very popular webinar, Stock Option Exercise Strategies: Advanced Bootcamp. During this educational event, three experts in option financial planning presented their tips for making the most of an option grant, from basic to advanced concepts. Some of the insights from these option gurus are summarized below.

The Tao Of Stock Options: Be Patient, Grasshopper

Taoism tells us that mindfully strategic inaction, expressed in the concept of wu wei (literally "doing nothing" in Chinese), is often the most effective approach to the challenges of living. And so it often is with employee stock options. Waiting as long as possible to exercise stock options—i.e. doing nothing and letting the value grow until a strategic moment—is often the soundest exercise strategy.

It’s important to note that there are two types of stock options with very different tax treatments. Nonqualified stock options (NQSOs) are the simpler and more common type. Incentive stock options (ISOs) are less common and more complex in that they can offer potential tax advantages but more risk. Most of the discussion in this article concerns NQSOs in public companies.

1. Waiting To Exercise Is Often Best

Stock options let you buy shares of your company’s stock at a fixed price for a specified period, typically over a term of 10 years. Under nearly all grants, you have to work at the company for a specified length of time (the vesting period) before you can exercise the options. If you leave your company, the vesting stops and the term usually ends much earlier, requiring you to exercise the options soon after your departure to prevent forfeiture. These rules and time periods can vary according to the reason you left work (e.g. job change, disability, death, retirement).

Private companies sometimes grant stock options that employees can exercise early, allowing you to start the capital gains holding period sooner and recognize little or no income at vesting. You want to check whether you have this type of stock option and carefully follow the rules (e.g. a timely Section 83(b) election), though this is not the focus of this article.

Options Align Your Pay With Company Performance

In short, stock options let you share in the growth of your company's value without any financial risk until you exercise the options (i.e. acquire shares). If your company’s stock price rises during the option term, the discount between the current stock price and your lower exercise price (the “spread”) can make stock options valuable for creating substantial wealth.

Leverage And Tax Deferral

The fixed purchase price creates the famous financial “leverage” of stock options. For example, if the stock price rises by 20%, the value of your unexercised stock options grows by much more than 20%. As soon as you exercise the options and thus purchase actual shares of stock, the leverage ends. Thus it’s important to think carefully about the right moment to make that move.

Moreover, while cash bonuses and most other forms of compensation are taxable when you receive them, stock options defer taxes until you exercise them. Before you exercise your options, their built-in value is subject to pre-tax growth—which can be significant.

For all of these reasons, the panelists in the myStockOptions webinar agreed: often no advantage exists in exercising nonqualified stock options in a public company soon after vesting, paying taxes on the spread, and then holding the shares for long-term capital gains (unless special circumstances occur, such as job termination). As long as the stock price continues to rise, thus increasing the spread over the exercise price, the leveraged value of the options grows without any tax hit, and your net after-tax proceeds will be larger.

In other words, the “Tao of Stock Options” might be the paradox that doing nothing for as long as possible could confer the greatest value.

Opportunity Cost

Consider also the opportunity cost of exercising and holding NQSOs. Financial advisors often liken stock options to an interest-free loan. “An option’s value is enhanced by the ability to use the capital that would otherwise be invested in the stock for some other investment,” said webinar panelist Bill Dillhoefer, CEO of Net Worth Strategies (creator of the StockOpter decision-making tool for employee stock options).

For example, he explained that if your options have a 10-year term and the company’s stock price keeps rising, the options have growing tax-deferred value before you have spent any money on them. Funds that you would otherwise put into buying the company’s stock can be used for other investments, then directed later into the option exercise at a strategic moment for larger gains.

Bill’s approach, which he detailed in the webinar, applies various ratios that consider special factors to calculate the optimum time to exercise options. For instance, when the stock price is much higher than the exercise price, these options with a big spread have less leverage and smaller upside from stock-price increases. These are the NQSOs that you might want to exercise and then immediately sell the shares.

2. Risk Versus Reward

As always with investing, stock options involve risks as well as rewards. If the stock price plummets below your exercise price, the value of the options vanishes (i.e. they go “underwater”). Decisions about when to exercise must therefore factor in the outlook for the company’s stock price.

The webinar panelists also discussed the risk of overconcentration, i.e. having too much of your net worth tied up in the stock of just one company. A single stock price can quickly fall. A diversified stock portfolio helps to mitigate that risk. When you calculate your concentration level, you should include any vested stock options you have. That can give you yet another reason to wait on exercising your options until you have a solid post-exercise plan that includes selling shares for diversification.

How can you balance the risks and the rewards? “Fundamentally, it is useful to base decisions with any type of equity award primarily on financial goals, timeframes for those goals, and the investment risk along the way,” explained David Marsh, Financial Planning Case Manager with Ameriprise Financial.

“Create perspective,” asserted his fellow webinar panelist Megan Gorman, a financial advisor, founder of Chequers Financial Management, and a Forbes senior contributor. “If you show the best-case scenario, also show the worst.”

To lessen concentration risk and promote diversification, a strategy formulated with a financial advisor should also extend well beyond exercise, said Megan. “Have a strategy on selling stock and where the proceeds are going to be reallocated to.” When you have a strategy, one way to document it (and provide some protection from accidental insider trading) is with a Rule 10b5-1 trading plan. She uses these for her executive clients.

3. Taxes

All of the webinar panelists agree that taxes should not be the principal driver of decisions. “While taxes are key factors, it’s dangerous to base decisions principally on tax aspects and neglect coordination with goals and investment risk,” warned David Marsh. In other words, chimed in Megan Gorman, the tax tail should not wag the option dog.

Nevertheless, Megan continued, it is important to model tax scenarios for your stock options and be prepared. “To build wealth, you have to deal with tax consequences.”

She added that for NQSOs you should “be prepared for your company’s tax withholding at exercise to not be sufficient to cover tax bill.” The IRS default statutory withholding rate of 22% for supplemental income, such as the spread at option exercise or restricted stock unit (RSU) vesting, is often lower than your actual income-tax rate. While the withholding rate jumps to 37% for supplemental wage income in excess of $1 million during the calendar year, employees between those extremes will have to plan how to pay the taxes not covered by the 22% default rate. The shortfall can be paid in quarterly estimated taxes based on the amount owed, among other methods.

4. Understand The Stock Plan Documents

One of the biggest mistakes with stock options is failing to read the stock plan documents and not fully understanding the terms of the grant, according to the experts in the webinar. “Grant info needs to be organized, saved, and updated to provide ongoing guidance,” cautioned Bill Dillhoefer.

Chief among the option terms to know are the vesting provisions and what would happen upon job termination, which usually triggers a very short window for option exercise before the grant term expires. “It’s crucial to clarify equity awards’ terms for vesting and at separation of service,” stated David Marsh. “Realize they may not all be the same.”

He also noted that many optionholders neglect to designate a beneficiary for vested stock options in case of death. “This is usually allowed in the plan, but often employees are unaware of that.”

5. Seek Help From A Qualified Advisor

“Stock options are complex employee benefits,” asserted Megan Gorman during her segment of the webinar. “Complex benefits require us to move slowly and think through issues.”

She implores optionholders to obtain guidance from a financial advisor and tax experts with experience in stock options, and to avoid relying on tips from co-workers. “Exercise strategies are incredibly personal,” Megan emphasized. “For your own unique situation, you may need to do very different things than your colleagues.” Bill Dillhoefer echoed this sentiment, observing that applying advice from “water-cooler” chats with co-workers about stock options can lead to mistakes.

More Insights Into Option Exercise Strategies

For many more insights about option exercise strategies, see financial-planning articles by expert contributors at myStockOptions.com. In addition, the webinar where Bill, David, and Megan presented advanced planning strategies and case studies, involving both NQSOs and ISOs in public and private companies (Stock Option Exercise Strategies: Advanced Bootcamp), is available on demand at the myStockOptions Webinar Channel (more details on that below).

myStockOptions Webinar Channel

See the myStockOptions webinar channel to register for our upcoming webinars and purchase our past webinars on demand in streaming format. On-demand webinars include:

Restricted Stock & RSU Financial Planning: Advanced Bootcamp (100 mins). This lively webinar features insights from a panel of three leading financial advisors, including case studies, to provide practical info, guidance, and expertise for restricted stock/RSUs in both public and private companies. 2.0 CE credits for CFP, CPWA, CIMA, and CEP.

Stock Option Exercise Strategies: Advanced Bootcamp (100 mins). Stock options can offer great leverage, but it must be wielded wisely. It is crucial to have a strategic plan for stock option exercises. This webinar features compelling insights from a panel of three experts in option exercise strategies. 2.0 CE credits for CFP, CPWA, CIMA, and CEP.

Stock Compensation Bootcamp For Financial Advisors (100 mins). Whether you are new to stock comp or want to sharpen your knowledge, our bootcamp webinar provides practical information and insights to maximize success. 2.0 CE credits for CFP, CPWA, CIMA, and CEP.

Strategies For Concentrated Positions In Company Stock (100 mins). Wealth is won and lost through the management of concentrated company stock positions. In this webinar, experts at managing concentrated stock wealth explain the wide range of strategies and solutions available for preventing losses and meeting goals. 2.0 CE credits for CFP, CPWA, CIMA, and CEP.

Know Your Options: Comparing NQSOs And ISOs

Stock options became famous during the 1990s. It was then that many companies, even those beyond the tech industry, started to make broad-based option grants to rank-and-file employees, not just to executives, as a strategy to lure top talent. Even Seinfeld took notice. "So," Elaine says to Jerry and George in "The Money" (1997), "you understand how my Peterman stock options are gonna work?" While George (of course) feels only petty envy that she makes more than he does, it is a very good question. Before you exercise employee stock options and do any financial planning with them, you need to understand which type of options you have and their tax treatment.

While since the 1990s many companies have come to favor other equity grants, such as restricted stock units (RSUs) and performance shares, stock options remain a major form of equity compensation. Companies can grant two types: nonqualified stock options (NQSOs), the more common variety, and incentive stock options (ISOs), which offer some tax benefits but also raise the complexities of the alternative minimum tax (AMT).

Which Type Of Options Do You Have?

Before exploring the differences between NQSOs and ISOs, you must check your grant agreement and know which type of options you have. Many companies now have omnibus stock plans in which they are authorized to grant not only both types of stock options but also restricted stock, RSUs, performance shares, and stock appreciation rights (see, for example, Uber’s 2019 equity incentive plan). This is why you need to look at your specific grant to be sure of the award type you are receiving. If it’s still not clear to you, then ask the stock plan administrator or person at your company in charge of managing the employee stock option plan.

Nonqualified Stock Options

A nonqualified stock option (NQSO) is a type of stock option that does not qualify for special favorable tax treatment under the US Internal Revenue Code. Thus the word nonqualified applies to the tax treatment (not to eligibility or any other consideration). A few basic NQSO facts:

• NQSOs are the most common form of stock option and may be granted to employees, officers, directors, contractors, and consultants.
• Unexercised NQSOs can be transferred to others, such as upon divorce or gifting.
• There is no tax-code limit on the total number or value of NQSOs that can be granted.

You pay taxes when you exercise NQSOs. For tax purposes, the exercise spread is compensation income and is therefore reported on your IRS Form W-2 for the calendar year of exercise.

Example: Your NQSOs have an exercise price of $10 per share.

• You exercise them when the stock price is $12 per share.
• You have a $2 spread ($12 – $10) and thus $2 per share in ordinary income.
• You sell the stock at $16 per share, giving you $4 per share in capital gains ($16 –$12 tax basis). Whether the gain is long-term or short-term depends on your holding period after exercise.

When you exercise NQSOs, your company will withhold taxes: federal income tax, Social Security (up to the yearly limit), Medicare, and state taxes (if applicable). This withholding appears on your Form W-2 for that calendar year.

When you sell the shares, whether immediately at exercise or after a holding period, you need to report the stock sale on Form 8949 and Schedule D of your IRS Form 1040 tax return. For a detailed explanation of the tax rules, see the related sections of the Tax Center at myStockOptions.com.

Incentive Stock Options

Incentive stock options (ISOs) qualify for special tax treatment under the Internal Revenue Code and are not subject to Social Security, Medicare, or withholding taxes. However, to qualify they must meet criteria specified under the tax code:

• ISOs can be granted only to employees, not to directors, consultants, or contractors.
• There is a $100,000 limit on the aggregate grant value of ISOs that may first become exercisable (i.e. vest) in any calendar year.
• For an employee to retain the special ISO tax benefits after leaving the company, the ISOs must be exercised within three months after the date of employment termination (longer periods apply for disability and death).
• Unlike NQSOs, ISOs cannot be transferred to others (e.g. upon divorce or by gifting).

ISO Holding-Period Rules: Benefits But Risks

After you exercise ISOs, if you hold the acquired shares for at least two years from the date of grant and one year from the date of exercise, you incur favorable long-term capital gains tax (rather than ordinary income tax) on all appreciation over the exercise price. Meeting the holding-period requirements of an ISO can result in substantially lower taxes.

Example: Your exercise price is $10, i.e. the stock price at grant. You exercise when then market price is $15.

Holding period	Sale price	Taxable income
Less than 1 year from exercise*	$17	$5 ordinary income (reported on W-2) + $2 short-term gain
1+ year from exercise, 2+ years from grant	$17	$7 long-term capital gain, no ordinary income

*ISO taxation depends on: (1) when shares are sold; (2) the sale price relative to the exercise price and the market price at exercise.

However, the exercise spread on shares acquired from ISOs and held beyond the calendar year of exercise can subject you to the alternative minimum tax (AMT) and additional tax-return reporting (e.g. Form 6251). This can be problematic if you are hit with the AMT on paper gains but the company's stock price then plummets, leaving you with a big tax bill on income that has evaporated.

Alert: If you have been granted ISOs, you must understand how the AMT can affect you. You should do an AMT calculation whenever you exercise ISOs and hold the shares.

Summary

The table below, from myStockOptions.com, summarizes and compares selected major traits of NQSOs and ISOs.

Option type	Eligibility	Event that triggers taxes	Taxes	Withholding?	Tax at sale
NQSOs	Company employees, executives, directors, contractors, and consultants	Exercise	Ordinary income tax, Social Security, and Medicare on the exercise spread	Yes, at exercise	Capital gains tax
ISOs	Only company employees and executives	Sale, unless AMT incurred	Ordinary income tax, AMT, or none*	No	Capital gains tax*

*ISO taxation depends on: (1) when shares are sold; (2) the sale price relative to the exercise price and the market price at exercise.

Further Resources

For more knowledge and financial-planning insights on these different types of stock options, see the NQSO and ISO sections of myStockOptions.com. To discover what your gains would be after exercising options and selling the stock, try the site's Quick-Take Calculator for Stock Options and other tools. For potential differences in these grants at private companies, see the section Pre-IPO at myStockOptions.com.

Tax-Rate Uncertainty Complicates Year-End Planning For Option Exercises & Company Stock Sales

Future tax rates on your mind? You're not the only one. Although less than three weeks remain before the current tax law ends at the close of 2012, the tax landscape beyond is still unclear. Unless a compromise is reached in Washington, tax rates will rise, though so far only the 0.9% Medicare tax increase and new 3.8% Medicare surtax seem to be beyond any possibility of modification.

In our most recent quarterly newsletter, we introduced two new FAQs discussing strategies with stock options and company stock holdings in light of potential tax increases after 2012. Both FAQs, also available in our section Year-End Planning, are reproduced in full below.

With the potential for tax-rate increases in 2013, I am thinking about exercising my nonqualified stock options to accelerate income into 2012. What issues do I need to think about?

Before you rush into exercising, you may want to do some calculations with potential future stock prices and tax rates. When you exercise earlier than necessary and pay taxes on your option spread, you lose some of the leverage that stock options offer. Experts feel the likelihood of higher tax rates ahead should not be the only reason for exercising at the end of 2012. The tools on myStockOptions.com, including the Quick-Take Option calculator, can help you consider various "what if" scenarios.

Here are some general situations where it makes sense to evaluate whether you should exercise options in 2012 rather than later:

• You were already planning to exercise options in next few years.
• The options are close to expiration.
• The options are deep in the money (i.e. there is a big spread between the market price and the exercise price).
• You need to diversify because your holdings are overly concentrated in company stock.
• You plan to change jobs soon. (Vested options almost always expire if they are not exercised soon after leaving the company.)

I am thinking about selling some company stock this year, before the new 3.8% Medicare surtax and the potential rise in capital gains tax rates, and then repurchasing it. This would reset the basis. What are the issues I need to consider?

By selling stock at a gain and then buying it back at the current price, you create a new basis in the stock. Because the shares are sold for a gain, there is no wash sale to worry about. The main reason for selling would be to avoid higher capital gains tax rates in a future year and the new Medicare surtax on net investment income. Compare this technique to tax-loss harvesting, in which stock is sold at a loss (without repurchase) to have future losses that can be netted against gains (another year-end planning strategy).

Example: You own company stock worth $100,000. The tax basis is $60,000. If you sell it now, you have $6,000 taxes on a $40,000 gain (at the current 15% capital gains rate). If you buy the stock back at same time, you obtain a $100,000 basis for a future sale.

Before you decide to do the same type of transaction, consider these issues in the situation presented by the example above:

• Check the size of capital-loss carry-forwards or losses from this year. Depending on your prior tax-loss harvesting, you may have $40,000 in losses to net against gains. If so, you can wait on a sale until the future, as you would not be paying any tax on gains up to that amount.
• Decide how you will pay the taxes and think about alternative uses of that money.
• Individuals who may be close to death should consider that the step-up in basis which occurs at death eliminates entirely the tax on the gain (i.e. you would want to wait on the sale).
• Think about whether a sale would trigger an unwanted disqualifying disposition for shares acquired through an employee stock purchase plan or incentive stock options.
• Remember that insider-trading rules and company blackouts may prevent sales and purchases. Unless you already have a Rule 10b5-1 plan in place, best practices for these plans usually require more than a few weeks to elapse between the time of plan setup and the first sale under the plan.

Got Eight Minutes? Get The Facts On The New IRS Forms & Reporting For Stock Sales

If there's a way to make learning about tax forms fun, we'll try it. In the Tax Center at myStockOptions.com, we just published an animated presentation on the expanded IRS Form 1099-B, the new IRS Form 8949, and the revised Schedule D. It's a painless way to learn these important developments and prevent expensive mistakes on tax returns during the imminent tax season.

In a concise, engaging overview, our editor-in-chief Bruce Brumberg will inform you about:

• the expanded reporting on Form 1099-B, and why the reported cost basis may be wrong or omitted
• how to figure out the right cost basis for your stock sales
• the new Form 8949 and how to report stock sales on it
• how to interpret Form 1099-B when completing Form 8949
• what to do when the cost basis in Box 3 of Form 1099-B is too low or not given
• totaling the reported stock sales on the revised Schedule D

Need further information? There's plenty more where that came from. A new article and FAQ at myStockOptions.com give full coverage of these tax-return topics. Additionally, our special section Reporting Company Stock Sales presents FAQs with annotated diagrams of Form 8949 and Schedule D. Each FAQ explains and illustrates a different reporting situation involving stock options, restricted stock, restricted stock units, performance shares, employee stock purchase plans, or stock appreciation rights. Clear instructions and diagrams show how to complete the forms, whether the cost-basis information on Form 1099-B is accurate, too low, or omitted.

Stock Comp Income & Withholding On Your Form W-2? Time For Our FAQs & Diagrams

Form W-2 is in the air—or, hopefully, safely in your mailbox or desk by now. If you had income from stock compensation or an employee stock purchase plan in 2011, you need to understand where that income is reported on the W-2 so that you can complete your tax return properly. In the award-winning Tax Center at myStockOptions.com, we have a series of FAQs dedicated to interpreting this sometimes cryptic document. These FAQs include annotated diagrams of Form W-2 that clearly show you around the form.

Stock Options

If you exercised nonqualified stock options last year, the income you recognized at exercise will be reported on your W-2. The income from a nonqualified stock option (NQSO) exercise appears on the W-2 with other income in:

• Box 1: Wages, tips, and other compensation
• Box 3: Social Security wages (up to the income ceiling)
• Box 5: Medicare wages and tips
• Box 16: State wages, tips, etc. (if applicable)
• Box 18: Local wages, tips, etc. (if applicable)
• Box 12 (Code V)

That last item, Code V in Box 12, identifies the NQSO income included in Boxes 1, 3, and 5. For the places where the tax-withholding amount appears, see our FAQ on W-2 reporting for NQSOs. (The W-2 reporting is, by the way, identical for stock appreciation rights, with the exception that Code V is not used.)

With incentive stock options, the spread value appears on the W-2 only when you make what is technically called a disqualifying disposition, i.e. when you sell or gift the stock before you have met the required holding periods of one year from exercise and two years from grant. In that case the income appears on the W-2 as compensation income. Unlike with NQSOs, your company does not withhold federal taxes on ISO exercises and no money is owed for Social Security and Medicare, even with a same-day sale or any later disqualifying dispositions. For the details of W-2 reporting for ISOs in this situation, see our FAQ on this topic in the Tax Center.

Restricted Stock, RSUs, Performance Shares

The vesting of restricted stock, the share delivery from restricted stock units (RSUs), and the vesting of performance shares all prompt W-2 reporting of the income received. The treatment on the W-2 is essentially the same for all three grant types. Income appear in the following places:

• Box 1: Wages, tips, and other compensation
• Box 3: Social Security wages (to income ceiling)
• Box 5: Medicare wages and tips
• Box 16: State wages, tips, etc. (if applicable)
• Box 18: Local wages, tips, etc. (if applicable)

To learn which boxes show the taxes withheld, and other reporting details for all three grant types, see the related FAQs, including annotated diagrams, in the Tax Center.

Alert: If you made a Section 83(b) election to be taxed on the value of restricted stock at grant, your W-2 for the year of grant, not vesting, will show the income and withholding.

Employee Stock Purchase Plans (ESPPs)

The W-2 reporting for ESPP income depends on whether your company's ESPP is tax-qualified or not and, if it is tax-qualified, how long you hold the shares. For a nonqualified ESPP, there is withholding on the income you recognize at purchase, and the income and withholding are reported on your W-2 in a way resembling that for nonqualified stock options. With a tax-qualified ESPP, nothing appears on your W-2 until you sell the shares. The details of all three situations are clearly presented, with annotated diagrams, in the section on ESPP W-2s in the Tax Center at myStockOptions.com.

Sell Shares In 2011? The Fun Ain't Over Yet

If you sold shares from stock compensation or an ESPP last year, you'll need more guidance to report the sale proceeds on your tax return. Fortunately, the Tax Center at myStockOptions.com features the section Reporting Company Stock Sales. Each FAQ in the section includes annotated diagrams of Form 8949 and Schedule D, the two crucial forms for stock-sale reporting.

Resources For Stock Plan Professionals

All of our tax-season content, including our popular annotated tax forms, is available for corporate licensing. Help your participants make the most of their stock compensation by giving them resources for avoiding expensive mistakes on tax returns. The excellence of our resources is attested by the many testimonials we have received, so don't just take our word for it. As one of our licensees puts it, employees "find the tax information and annotated tax forms extremely helpful." In the words of another client, "employees understand concepts much better with the straightforward illustrations." Please contact us for licensing details (617-734-1979 or [email protected]).

A Tale Of Two Equity Awards: Apple's Time-Vesting RSUs And HP's Performance-Vesting Options

Not long after the death of Steve Jobs had faded from the headlines, stock grants to senior executives at Apple generated coverage in many news reports (see, for example, Apple Awards Senior Execs $60 Million Each, Computerworld, Nov. 7). Related commentary and opinion about the Apple grants cropped up in blogs (e.g. Apple's Stock Awards: Well, At Least They're Not Backdating Options Again by Tim Worstall, Forbes, Nov. 8). To sum up the awards: six senior Apple executives each received a grant of 150,000 restricted stock units, half of which vest in June 2013 and half in March 2016; the company made a separate grant of 100,000 RSUs to another VP, apparently as a retention method.

Indeed, executive retention seems to be the recurring theme here. Looking at the executives' related Form 4 filings (required within two days of grant under Section 16 rules), we see that the grants do not have any performance-vesting features. In fact, the vesting of these RSUs seems to be based entirely on continued work at the company and not on any type of performance goal, such as total shareholder return, revenue, or earnings per share. Nowadays, under scrutiny from shareholders and the media, many companies would not dream of making big equity awards without performance-vesting features for at least part of each grant. But Apple seems to have other priorities now. As noted in the Forbes blog, "the death of Steve Jobs has clearly meant that securing and solidifying the management team is a good idea. They're locked in for years in order to actually get their hands on these shares, to be able to sell them."

By contrast, performance-vesting features do factor heavily in the stock option award Hewlett-Packard made to its new CEO Meg Whitman. Options with performance features are not that common, though they have occurred upon the hiring of other new CEOs in recent years. Ms. Whitman's grant received extensive media coverage (e.g. HP CEO Meg Whitman's Salary: $1, CNN Money, Sept. 30). This is understandable, given HP's recent history of controversy involving CEOs and Ms. Whitman's own recent history at eBay.

At HP, Ms. Whitman received a grant of nonqualified stock options for 1.9 million shares. According to the Form 8-K announcing the arrangements for both the former and the new CEO, the options have an eight-year term, and almost all will vest only if the company's stock price enjoys a 40% increase during her time of employment:

• 100,000 shares vest annually over three years
• 800,000 options vest after one year if the stock price exceeds by 120% the exercise price of the options for at least 20 consecutive trading days
• 800,000 options vest after two years if the stock price exceeds by 140% the exercise price of the option for at least 20 consecutive trading days

For more about performance share grants, including survey data about company practices, see the section Restricted Stock: Performance Shares at myStockOptions.com.

Tax Return Time Is Over, But Estimated Taxes Are Never Out Of Season

Now that tax return season is over (hope it was good for you), it's time to look at the tax year ahead. Federal tax law requires you to pay at least 90% of your income tax liability during the year through either withholding or quarterly estimated tax payments (with a few safe harbor exceptions). If an option exercise or restricted stock/RSU vesting increases your income so that the standard withholding percentage is insufficient, you may need to pay estimated taxes to make up the difference and avoid paying penalties and interest. (The standard withholding percentage for federal tax on supplemental income is 25%, but the percentage is 35% for amounts of supplemental income over $1 million during a calendar year.)

You make quarterly estimated tax payments by the 15th (or next business day) of April, June, and September in the year of exercise/vesting and January of the following year. The deadline for the first quarter of 2011 recently passed on April 18. The next due dates for the 2011 tax year are June 15 and September 15 of 2011 and January 17 of 2012. One safe harbor approach is to make estimated payments, along with any salary and supplemental income withholding, that equal at least 100% of the previous year's total tax. For people with adjusted gross incomes (AGI) of more than $150,000 (or $75,000 if married and filing separately), the safe harbor level is 110% of the prior year's tax.

If you must pay estimated taxes, one small strategy is to exercise stock options just after the start of an estimated-tax period rather than just before it ends. See myStockOptions.com for other strategies involving estimated tax payments, for the safe harbors that let you avoid penalties, and for details on estimated taxes with NQSOs, ISOs, restricted stock/RSUs, and stock appreciation rights.