WEBINAR: Our year-end webinar is available on demand: Year-End Financial & Tax Planning For Equity Comp. Agenda and panelist details are on the webinar registration page.

Year-end planning for stock compensation and company shares can be tricky. We asked several leading financial advisors for their ideas on financial and tax planning for the end of the year and the start of the next. Below are their responses, presented in their own words.

Stephanie Bucko
Mana
Los Angeles, California

Our happiest clients are the ones who have committed to holding a specific percentage of their company stock—and no more. Why are they the happiest? Sticking to a percent of net worth removes emotional decisionmaking. We use year-end as a final check for aligning our clients' finances with their goals, and optimizing where possible. Everyone's plan is different, but we'll share some of our top ideas on what you might consider for your stock compensation, specifically focusing on RSUs.

We use year-end as a final check for aligning our clients' finances with their goals, and optimizing where possible.

  • Review your current stock holdings. If you're overconcentrated in your company's stock, take the opportunity to sell some positions, targeting those that are at a loss. You can deduct up to $3k of losses on your tax return this year, and the rest carry over to future years!

  • Don't focus only on losses. If you're in a lower income year than usual, you might use this as an opportunity to sell stocks, even if they are at high gains. Capital gains tax brackets are similar to ordinary income tax brackets, whereby you pay more tax when your income is higher. If you're in a lower bracket, you might be able to lock in 0% or 15% versus 20%, and avoid the 3.8% net investment income tax.

  • If you haven't adjusted your withholding rates on your RSUs, check that you have enough in savings for taxes this year. RSUs are automatically withheld at 22% for less than $1 million, so if you're in the top tax bracket of 37%, you'll want to have saved 15% of your vested stock for tax purposes.

  • With proceeds of sales, diversify! Both stocks and bonds have lost money this year. Investing in stocks during a down market can be accretive over the long term. With interest rates on the rise, bonds are now generating yields where investing is compelling. Don't focus on what's lost; look at what's ahead!

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Sheri Iannetta Cupo
SAGEBroadview Wealth Management
Morristown, New Jersey

Rather than letting your equity compensation drive your financial circumstances, flip that planning on its head. First define your life's goals—such as educating your children, achieving a desired lifestyle, or retiring within a particular timeframe—and then let those goals drive your stock option or restricted stock decisions. That being said, you still want to make tax-smart decisions. We advise working with a tax professional to create a multi-year tax projection using your best estimate of what your 2022, 2023, and 2024 tax situations will look like. Then deploy the tax-planning strategies for your stock options, restricted stock/RSUs, and company shares that seem most appropriate.

If you plan to hold the investment for a few years or more, consider harvesting the gain by selling the appreciated position and then buying back the investment, thereby resetting the cost basis higher to help with any future sales.

Key metrics to know about your tax situation include:

  • Are you subject to regular tax or the alternative minimum tax?
  • What is your marginal tax bracket?
  • Are you subject to the 3.8% Medicare surtax?

Some tax-planning ideas follow:

Capital gains. For people who (1) have appreciated positions in their company stock holdings, (2) have no loss carry-forwards, and (3) in 2022 expect to be taxed at a 15% or lower long-term capital gains rate AND expect to avoid the 3.8% Medicare surtax:

  • If it is likely the money will be needed sooner rather than later (e.g. for college), or if you anticipate you will change the investment in the near future (e.g. you have a concentrated position in employer stock, so you plan to sell to invest proceeds in a diversified portfolio), then consider harvesting long-term capital gains this year.

  • If you plan to hold the investment for a few years or more, consider harvesting the gain by selling the appreciated position and then buying back the investment, thereby resetting the cost basis higher to help with any future sales. Keep in mind that wash sale rules apply only to losses. The shorter the period between the gain-harvesting sale and your second long-term capital gains sale, the more favorable gain harvesting becomes. Additionally, the greater the difference between your 2022 tax rate and the tax rate when you resell the stock, the greater your potential return from this strategy. For example, if you expect to be in the 0% capital gains bracket in 2022 and then the 15% or 20% bracket in 2023, consider harvesting the gain in 2022 to get a free step-up in basis. Or, if you expect to be in the 20% capital gains bracket in 2023 and therefore subject to the 3.8% Medicare surtax, consider harvesting the gain in 2022.

Editor's Note: For more details on selling stock to reset the basis, see a related FAQ.

For people with an appreciated stock position and substantial loss carry-forwards: If you expect that you will incur higher tax rates in the near future, then consider preserving the loss carry-forwards by deferring them to a year when they can be applied against a higher capital gains rate, providing you with greater tax savings.

Alternative minimum tax (AMT): for people in it now and likely to stay in it. When planning for AMT, create a tax projection to find the break-even point where your regular tax liability and your AMT tax liability are equal. Then you can better understand how the AMT affects your tax liability. The AMT exemption amount is subject to a phaseout. This phaseout can cause even higher AMT rates (marginal rates between 32.5% and 35%) because each additional dollar amount of income causes $0.25 of the AMT exemption to phase out until the full AMT exemption amount has been phased out.

  • You can consider exercising incentive stock options in years when they will not phase out the AMT exemption.
  • Conversely, you may wish to shift more income into high-income years when the AMT exemption has already been phased out and you would benefit from paying tax at the 28% top AMT tax rate rather than at a higher ordinary tax rate.

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Bruce R. Barton
Parkworth Wealth Management
San Jose, California

Disqualifying dispositions of ISOs in down markets. If you exercised an incentive stock option (ISO) early this year, ahead of the stock market downturn, you may be in for an unhappy surprise when you file your tax return in April—unless you act now.

If you exercised an ISO early this year, ahead of the stock market downturn, you may be in for an unhappy surprise when you file your tax return in April—unless you act now.

That's because the amount of taxable income from the option exercise was determined at the time you exercised your option. If your company's stock price has dropped since then, you may still have a gain, and you may still owe tax, based on the higher price of the company's stock when you exercised. Remember that even though an ISO exercise is not taxable under the regular tax system, any gain in value of your shares—defined as fair market value at exercise, less strike price times number of shares—is taxable income under the alternative minimum tax (AMT) system.

To reduce or possibly eliminate your tax owed, you may want to consider selling the shares from the ISO exercise before year-end in a disqualifying disposition. Selling the shares before year-end will allow them to be taxed according to their gain as of the date of sale instead of the date of exercise. If the stock price is lower now when you sell than at the beginning of the year when you exercised your option, the gain may be less—potentially much less, or even a loss.

This type of sale is called a disqualifying disposition because you intentionally violate the special holding-period rule that qualifies your sale for long-term capital gains treatment under the regular tax system. The holding-period rule requires that you sell your shares at least two years after the date of grant and one year after the date of exercise. By selling within the year of exercise, you violate the second part of the rule, and any gain on the sale will be taxed as ordinary income under the regular tax system; there will be no income or tax under the AMT system. You will pay tax at the higher ordinary income tax rates, but selling in a disqualifying disposition could allow you to pay tax on much less income and thereby lower your overall tax bill.

One word of caution when considering a sale. If you buy your company's stock within 30 days of the sale (before or after), you will trigger the IRS wash-sale rule and eliminate the benefits of your disqualifying disposition. It's easy to do this inadvertently, for example, with the automatic purchase of employee stock purchase plan (ESPP) shares or a planned exercise of stock options. Be sure to time your sale to avoid this wash-sale trap for ISO disqualifying dispositions.

If your company's stock has dropped significantly this year and you exercised ISOs, be sure to check whether a disqualifying disposition before year-end can reduce your tax bill.

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Chuck Steege
SFG Wealth Planning Services
Doylestown, Pennsylvania

Check for impending expiration dates, including any in-the-money stock option grants that may expire in the first quarter.

Take time to review your vested stock options. Check for impending expiration dates, including any in-the-money stock option grants that may expire in the first quarter. If you expect your tax rate to be higher in 2023, due to a promotion at work or another rise in taxable income, it may make sense to exercise stock options in 2022 that are slated to expire in the first quarter of next year. An executive who is retiring soon (and expects to benefit from a lower tax rate in 2022) may choose the opposite strategy and exercise closer to expiration next year.

If you plan to exercise before year-end, check your company's calendar for selling windows. Many companies have deadlines for option exercises and stock sales that close prior to the end of the year.

Exercise at or near expiration. Unless your tax situation calls for it, don't be hasty to exercise nonqualified stock options (NQSOs) early. Even if you plan to hold the stock for a long term and are considering an exercise now to start the capital gains period, think carefully before proceeding. Studies have shown that NQSOs generally make the most money when they are kept tax-deferred for as long as possible. It's a good idea to wait to exercise stock options until close to the expiration date of the option term. Any exceptions for tax purposes should be reviewed by your tax advisor.

Take time to update your beneficiary designations. Does your long-term incentive (LTI) plan offer the ability to designate a beneficiary? Be sure to consult your tax/legal advisor and financial advisor in advance of making your estate-planning decisions, particularly as it relates to LTI plan beneficiaries.

Unlike most retirement plans, such as 401(k) plans, there is no legal requirement for LTI plans to designate the award-holder's spouse as the default beneficiary. If your equity awards survive in the event of death, then your estate typically becomes the default beneficiary, unless you've adequately named a beneficiary on the LTI plan. Some LTI plans allow the award-holder to designate beneficiaries on some awards but not other awards. Also, some states invalidate beneficiaries listed on LTI plans, which can cause a dispute around who is the legal beneficiary. If you can legally designate beneficiary(s) on your LTI plan, then your awards will pass directly to them without being subject to probate or administration. It is important to remember that a valid will cannot change an LTI plan beneficiary, so be sure to update your LTI plan beneficiary(s) at the same time your estate-planning documents are updated (e.g. will, POA, advanced medical directives).

If the award-holder dies without an LTI plan beneficiary, then the ultimate distribution of awards will be determined by the existence of a will or not. If you have a will, then LTI awards will be distributed according to the beneficiaries listed in the will. If you do not have a will, then LTI awards will be distributed according to your state's law. Instead, it may be beneficial to set up a trust during your lifetime to transfer some of your awards to intended beneficiaries. Ownership and control over trust assets is paramount and should be considered before any decisions are made.

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Daniel R. Zajac
Zajac Group
Exton, Pennsylvania

Year-end planning for company stock and stock options should focus on both the big picture and the details. Big-picture items can include a review of your goals, objectives, and financial plan. A year is a long time for a stock price, and fluctuations in your company’s stock price may have made a material impact on the direction of your financial plan. If you haven’t taken the time to update your plan, year-end is a good reminder.

Specific year-end decisions may involve detailed tax planning up to important tax breakpoints.

Even if you have been updating your plan, year-end is a good time to strategize for the following calendar year. This may be even more important if you see major changes in your situation or that of the company. Retirement (see my related article), a new job, or a change in control of your company may have made a material impact on your plan. Being in front of the change with diligent planning may be strategically beneficial.

More specific year-end decisions may involve detailed tax planning up to important tax breakpoints. For example, you should consider exercising incentive stock options (ISOs) up to the alternative minimum tax (AMT) crossover point, the point where you can exercise ISOs and pay no AMT. You can also consider selling shares from previously exercised ISOs to the point where your adjusted gross income hits a higher capital gains tax rate, the threshold where AGI reaches the Medicare surcharge tax, or the point where you reach the AMT phaseouts.

Other specific year-end planning may include selling ISO shares in an intentionally disqualifying disposition should the stock price have dropped during the calendar year. This may protect you from paying more in AMT than what the stock is actually worth.

Finally, your planning can include an analysis to test the benefit of exercising nonqualified stock options or selling shares from restricted stock/RSU vesting or an ESPP purchase, any of which can increase your adjusted gross income. A higher adjusted gross income may create additional room to exercise ISOs with no AMT. An exercise-and-sell may also create cash that can be used to buy other shares or pay a pending tax bill.

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Kent T. Hickey
Ubequity Wealth Management
Austin, Texas

Begin with the end in mind. Equipped with your lifetime and financial goals, you and your advisors can design your equity compensation strategy to support and achieve those goals.

A well-designed equity compensation strategy can minimize the emotional rollercoaster of decision-making when the stock price is most volatile.

Take inventory of your holdings, including NQSOs, ISOs, RSUs, PSUs, ESPPs, and company stock holdings in taxable and retirement accounts. Include vested, unvested, and performance shares for which metrics have been achieved but shares have not yet vested.

  • Keep a schedule of vested and unvested shares and their expiration dates.
  • Plan for vesting and receipt of RSUs and PSUs throughout the coming year.
  • Request your company's open selling windows so you can exercise "in the money" options before expiration.

Maintain your inventory. Know your holdings and the cost basis of owned shares and you will easily identify which shares to sell to fund your goals, manage tax impact, avoid losing shares to expiration, and reduce single company stock risk.

Know your plan rules so you can accomplish your goals within the requirements.

  • Have you accepted all grants when offered?
  • Does an 83(b) election for restricted stock (not available for RSUs) make sense for tax planning?
  • What happens to equity compensation in the event of death, disability, change of control, retirement, termination, or separation from service? How would each of these events affect your goals?
  • Planning a transition? Consider your forfeit value and the grants, vesting, and value of what you leave behind based on your departure date.
  • Does your company offer a nonqualified deferred compensation (NQDC) plan? Have you considered pairing the NQDC to accelerate progress toward your goals while improving tax efficiency?

Improve your results by knowing the equity compensation rules when considering a company transition, adjusting your tax strategy, or negotiating your next opportunity.

Review your equity compensation strategy. A good strategic plan will clarify your decisions and actions throughout the year.

  • How much of your assets are tied to your company stock?
  • Are you inadvertently adding to an already concentrated portfolio?
  • What is your strategy for buying, selling, exercising, or holding options/shares to achieve your financial goals?
  • Do you support charities? If so, layering in charitable planning with your equity compensation plan can help to reduce taxes and maximize the charitable impact of your gifts.

A well-designed equity compensation strategy can minimize the emotional rollercoaster of decision-making when the stock price is most volatile. Remember to keep the end in mind as you design your stock compensation strategy. The combination of your goals and strategies have the power to change your life.

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Jane Yoo
Jane Financial
Oakland, California

After an initial public offering (IPO), a company typically forbids current and former employees from selling its stock for up to six months. If you work at one of these companies, be aware of three mental traps as you wait for the lockup to come off.

If you work at an IPO company, be aware of three mental traps.

Insider Optimism Syndrome: "I believe in my company's prospects." This is the #1 comment I hear. Reframe the issue as follows: "If your company paid $100,000 cash bonus, would you use this money to purchase company stock?" Most people quickly answer, "No, I'd keep the cash." If you answered "No," then treat the stock compensation as a bonus. Sell the shares immediately and keep the cash.

Breakeven-itis: "I want to hold out for the 'right' stock price before I sell." Beware the temptation of waiting to sell until you get the "right" price of "at least" $260 or whatever you're anchoring on. This can lead you into a trap of never selling the shares. If the stock price reaches your target, you might be tempted to set a new target price. Or if the stock price drops, I've seen clients express regret about selling "if only" the price were "at least" a dollar amount they've selected as their anchor.

Regret avoidance: "What if my company becomes the next Google or Amazon? I'll kick myself for selling!" FOMO is human nature. It's easy to judge decisions in hindsight. But you don't have the benefit of hindsight right now. It's difficult to predict stock prices. Warren Buffett himself recommends that investors select index funds rather than finding a professional manager who likely will perform worse than an index fund after fees.

Editor's Note: For more tips on IPO financial planning from Jane and other advisors, see Initial Public Offerings: Leading Financial Advisors On Equity Compensation Planning.

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AJ Ayers
Brooklyn FI
Brooklyn, New York

  • If offered at a private company and the circumstances are right, consider early exercise of your incentive stock options (ISOs) to freeze the bargain element. Typically, if you're one of the early hires, your strike price could be equal to the current 409A valuation, meaning you would not incur additional alternative minimum tax (AMT). Don't forget to file an 83(b) election within 30 days of exercise.

  • Be cautious about exercising any ISOs in a private company after mid-November if the 409A valuation is higher than your strike price—you'll potentially owe AMT for this tax year and won't have an opportunity to sell the shares until after some type of liquidity event or until your company allows secondary market resales. PLUS, waiting for the next trading window after the required one-year holding period, to get long-term capital gains on all the sale proceeds over the exercise price, could be as late as February of the following year.

    • Be cautious about exercising any ISOs in a private company after mid-November if the 409A valuation is higher than your strike price.

  • Consider more advanced tax-planning strategies if you have a mix of ISOs, NQSOs, and RSUs at a public company. Consider disqualifying some of your ISOs at a public company if the bargain element is too large. This strategy can also help minimize AMT on shares that you've already exercised this year. A financial advisor who is well versed in equity compensation and taxes can help you model different scenarios.

  • Qualified Small Business Stock (QSBS): it isn't just for venture capitalists. This unique part of the tax code allows early investors to reap fantastic tax benefits. If your shares meet the requirements to be considered QSBS, you could exclude up to $10 million from capital gains taxes if you're able to hold your shares for five years. Employees can take advantage, so reach out to your company's finance team to learn if your company met the QSBS requirements when you exercised and held shares.

  • Conduct a tax projection and see if you have any AMT-free exercises available—if so, don't leave that on the table. Exercise ISOs up to the amount that has you paying $0 in AMT.

  • Take a look at your AMT credit and how long it will take you to earn it back; determine if disqualifying some shares now makes sense as opposed to giving the federal government an interest-free loan.

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Mark Struthers
Sona Wealth
Edina, Minnesota

Putting some year-end thought into your short- and long-term goals is helpful not just for your equity and deferred comp decisions but also for how you invest other time and money.

November and December are joyous but stressful months. It is a time for family and a time when decisions should be made about your equity and deferred compensation. A simple approach to handle this is GIPS:

  • Goals. Putting some thought into your short- and long-term goals is helpful not just for your equity and deferred comp decisions but also for how you invest other time and money. Putting off difficult conversations around goals like college is all too easy, and the negative consequences are often not just financial.
  • Inventory. Taking an inventory of your equity and deferred compensation will help you see the forest and the trees. You can't make the most of what you have until you know WHAT you have.
  • Projections. Projecting out what income and taxes look like in the future will help you make better tax decisions. Filling up lower tax brackets with things like NQSO exercises and RSU vesting will help you avoid a tax surprise. It will also allow you to make the most of things like Roth conversions or limit the damage of RMDs.
  • Scenarios. The very nature of equity and deferred compensation involves risk. Concentration risk comes from the value and credit worthiness of the company you work for, not to mention that your income depends on them too. Running scenarios of the impact of a 2009-type event on equity prices or the effect of inflation on your fixed income will help you make better risk-conscious decisions.

Taking a little time at the end of each year to GIPS can help you make better financial decisions and reduce stress. There is enough stress from Uncle Bob talking politics each Thanksgiving, or if you're a Detriot Lions fan, watching them play!

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Paul Saad
Collabria Capital
San Ramon, California

Charitable gifting that focuses on low-cost-basis positions can help reposition concentrated holdings without adding to your tax bill.

Year-end is a good time to consider your concentration level in company stock and strategically diversify. It is often said that diversification is the only free lunch in investing. Because equity returns are largely unpredictable, being broadly diversified reduces idiosyncratic risk and increases the likelihood of capturing market returns.

However, events such as stock awards, vesting of stock options, and public offerings may result in highly concentrated portfolios. Should you sell your concentrated positions in order to diversify?

Besides the personal attachment to a particular investment and potential legal restrictions such as lockup periods, capital gains taxes associated with the sale of appreciated investments can be an important consideration—or you may wish to defer the tax bill indefinitely, potentially waiting for a step-up in basis and bequeathing the assets to the next generation.

Fortunately for investors concerned with after-tax returns, there are alternatives to immediate liquidation. For example, charitable gifting that focuses on low-cost-basis positions can help reposition concentrated holdings without adding to the tax bill—as will strategic diversification over time. Holding more positions increases the opportunity to capture benefits through tax-loss harvesting.

In times of ever-changing tax rules, holding a well-diversified portfolio is an important tool available to help manage uncertainty and achieve your goals.

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Dann Ryan
Sincerus Advisory
New York, New York

Are you considering taking part in The Great Resignation? Now would be an excellent time to review your offering documents and check the terms of your departure.

In addition to all these great strategies mentioned already here, there are a few very practical things you can do at year-end too.

Perhaps easiest is to obtain the list of your company's window periods for the upcoming year and put them on your own calendar. This makes it easy to coordinate with any life goals you might want to fund or to set price targets for potential planned selling. You could also sit down and create a timeline of the next few years that includes any stretch financial goals you want to achieve and what stock price that would coincide with.

Were you in AMT due to an exercise of ISOs this year? It may be helpful to strategize if you are going to be in AMT again in future years and when you will be able to use your Minimum Tax Credit. You don't have to just wait until you sell your shares.

Are you considering taking part in The Great Resignation? Now would be an excellent time to review your offering documents and check the terms of your departure. Are there any major vesting dates on the horizon you could stick around for? Frequently you may have up to 90 days after your departure to exercise any vested stock options. It's important to make a plan in advance to have the funds to exercise and pay any associated taxes. The terms could also be altered by a severance agreement. Read everything carefully!

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John Nersesian
US Global Wealth Management, PIMCO
Chicago, Illinois

Consider exercising NQSOs prior to December 31 to "fill" lower income tax brackets at favorable tax rates.

The end of the year provides a unique opportunity to provide valuable advice to clients who may hold restricted stock or employee stock options. Some examples:

  • Consider exercising nonqualified stock options (NQSOs) prior to December 31 to "fill" lower income tax brackets at favorable tax rates. For example, the 24% marginal rate applies to married filing jointly taxpayers for taxable income between $171,050 and $326,600. A client with taxable income of $172,000 has an opportunity to recognize approximately an additional $150,000 of income through option exercise at this marginal rate of 24% before reaching the next tax bracket.

  • Clients who have exercised incentive stock options (ISOs) might consider a qualifying disposition by holding the shares a minimum of two years from the date of grant and an additional one year from the date of exercise. This treatment would avoid the recognition of any imcome in the year of exercise and provide the opportunity for capital gains treatment in the year of sale. Of course, clients could find themselves subject to a potential AMT liability, as the bargain element would be included in the AMT taxable income in the year of exercise. This could be managed/avoided through a disqualifying disposition prior to December 31.

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Henry E. Zapisek
Cetera Advisor Networks
San Diego, California

The number-one action is taking a current inventory of your company stock holdings. This includes your held shares, restricted stock units (RSUs), nonqualified and incentive stock options, and warrants. You need a year-end snapshot of your equity holdings and equity compensation. The pertinent information, such as your cost basis of held shares and the vesting/exercise details of your RSUs and options, must be verified and updated as necessary. The key to making the right financial decisions is accurate information.

Update as necessary your cost basis in held shares and the vesting/exercise details of RSUs and options.

The second action item is to update your timeline with regard to the vesting/exercise dates of your RSUs, options, and warrants. Create and review reminders to give yourself enough time to work with your advisors to effectively manage your held stock and other equity compensation. Proper planning with your tax advisor will help avoid surprises in April and assist with cash-flow planning to meet your income tax obligations.

Third, January can be an excellent time to exercise vested "in the money" incentive stock options (ISOs). An exercise in January gives you the ability to time and control your alternative minimum tax liability. The sale of these exercised ISO shares in the same year results in a disqualifying disposition, which removes the threat of the AMT. On the flip side, if the sale occurs in the following year, you can qualify for favorable capital gains rates.

The final action item is to review your entire financial holdings against the backdrop of your company stock and equity compensation. Be very careful of concentration risk. The goal of every prudent investor should be balance and consistency in the investment process.

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Richard Friedman
Formerly with Ayco (now retired)
Albany, New York

Podcast: In addition to the year-end tips below, you can also listen to our interview of this author on general financial planning for restricted stock and RSUs.

Year-end planning for company stock holdings or stock unit exposure should continue to focus on traditional tax-planning and asset-diversification concepts. Individual planning priorities may be based on your position at the company (key executive, salaried employee, consultant or director), the amount of compensation payable in stock, and the amount of company stock held. With more long-term incentive (LTI) awards that become payable only if performance metrics are earned, you may be less able to control the timing of equity-based compensation than in the past. Here are some issues to consider.

If you hold "in the money" stock options that are scheduled to expire in the near future, e.g. by the end of 2022 or 2023, review whether it makes sense to exercise valuable options before year-end.

Review stock option exercise strategy. If you hold "in the money" stock options that are scheduled to expire in the near future, e.g. by the end of 2022 or 2023, or if you anticipate terminating your employment in the near future, you should review whether it makes sense to exercise valuable options before year-end. For NQSOs, the manner of exercise (cash, stock swap, or cashless) should be reviewed, along with how required tax withholding will be paid (in shares or in cash). For incentive stock options, the manner and timing of exercise should be considered, along with alternative minimum tax (AMT) considerations. This could lead to a plan to exercise ISOs in 2022 or 2023 due to adjustments in how the AMT is now calculated.

Uncertainty about future tax rates, including possible increases in the highest federal and state tax brackets and in the highest capital gains rate, could be a reason to review and consider an exercise of NQSOs and a sale of company stock or ISO shares. It could also mean that deferral of RSUs or PSUs, if available to you, needs to be thought through (see next paragraph). The stock market has been wobbly and could continue to be next year. While the stock market has reached an all-time high this year, there will continue to be market risks and uncertainties. A possible future imposed tax on stock buybacks could affect company stock prices.

Deferral of RSUs or other stock-based compensation. This could be a tax-savings planning tool, it but comes with some risk. If your employer allows you to defer RSUs, performance share units (PSUs), or other stock-denominated compensation, you should review the timing and procedure for making a valid deferral election. Under IRC Section 409A, this procedure may be part of, or separate from, the company's election window for the deferral of salary and bonuses—which typically is in the 4th quarter. You should also review whether any deferrals must remain denominated in company stock units, which is common due to the more favorable accounting treatment to the company, or whether you have a choice in the crediting rate for any amounts deferred. You also may have an opportunity to decide the timing of distributions for current-year deferrals.

401(k) and ESPP planning. Many companies are now limiting or prohibiting elective deferrals into a company stock account. If company stock is an available investment option in your 401(k) plan, year-end can be a good time to review your overall asset allocation and risk strategy. If your company matches your contributions in company stock, you should have an opportunity to move that match into other investments available under the plan. This should be reviewed. If your company offers a broad-based employee stock purchase plan, review the amount of any purchase price discount and when offering periods commence. If you don't receive stock-based compensation, an ESPP can be your opportunity to acquire stock, often at a discount, through convenient payroll deductions.

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Robert Gordon
Twenty-First Securities Corporation
New York, New York

Podcast: In addition to the year-end tips below, you can also listen to our interview of this author on hedging strategies for stock compensation.

January 1 is the time to exercise incentive stock options (ISOs). Incentive stock options are thought of more favorably than nonqualified stock options because ISOs can create capital gains while NQSOs create ordinary income. When employees exercise ISOs, no immediate taxable income is created. When an ISO is exercised, a new capital gains holding period is established with the employee's cost basis being the price paid for the stock (the exercise price of the option).

Employees should exercise their ISOs at the very beginning of the year, giving them a full year to make a sell decision that would have no AMT impact.

The ISO stock holding period begins on the day when the options are exercised. If the employee holds the stock more than 12 months from the exercise date (and 24 months from the grant date) and recognizes a gain upon the sale of the shares, the full gain is considered long-term. If the stock is held less than 12 months, part of the gain is considered compensation and is taxed as ordinary income (see an FAQ with examples). ISO stockholders, therefore, have an incentive to hold shares at least 12 months.

But that creates a dilemma. Should ISO shareholders hold the stock and hope for more gains, or should they sell immediately after exercise? The costs of being wrong can be dramatic but not always obvious. If an employee decides to hold the shares, there is the alternative minimum tax (AMT) trap to consider. In calculating the AMT, the difference between the purchase price (option strike price) and the market price is considered income. Importantly, the income is not AMT income if the shares are sold in the same calendar year as the option exercise. This is many times confused with the 12-month period necessary to qualify for long-term gains rates.

Unfortunately, many employees have seen the price of their ISO stock drop during the year after exercise as they waited for their shares to go long-term. Without AMT liability, an ISO stock decline would damage the stockholder economically but not in terms of taxes—in fact, if the shares are sold below the exercise price, the employee could possibly realize a capital loss. But if the ISO exercise has triggered an unforeseen AMT liability, the employee could owe significant taxes on worthless stock.

Because of this, employees should exercise their ISOs at the very beginning of the year, giving them a full year to make a sell decision that would have no AMT impact. If the stock falls, they should sell before December 31, which would trigger a short-term gain or loss but eliminate the AMT liability. At year-end, if the stock has risen, they could hold for a few more days into January for the 12-month holding period to be achieved and then sell for a long-term gain. This approach could trigger the AMT, but the economic gain should outweigh the tax liability. By contrast, if an ISO is exercised in October, the employee has only a short time before the end of the year to decide whether to sell before December 31 and avoid the AMT or hold for nine months more in order to qualify for long-term treatment.

Incentive stock options have proved a wonderful device for motivating employees, but they must be managed carefully. The takeaway: exercise in January for maximum flexibility, and remember to observe the value of the shares that are purchased before year-end—or expect the possibility of an AMT bill in the following April.

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For year-end ideas from another financial advisor, see Stockbrokers' Secrets: Year-End Planning For NQSOs, Restricted Stock, And RSUs.

The advisors who submitted written remarks for this article did not pay myStockOptions.com to have them included and were not compensated for their contributions. The statements made in this article do not constitute personal investment advice and may not apply to your individual circumstances. Consult a financial advisor directly to obtain guidance on your personal financial situation.