“I don’t want to leave more money to the IRS than my family when I die.”
This is a direct quote from a client I met with recently. We were reviewing his equity compensation strategy that my team and I helped him implement over the past few years. The discussion turned to his stock options that would be vested within the coming year. He had been talking about how well his company was performing and spoke proudly of how far the company had come during his time there. However, the smile on his face turned to a look of concern as he learned about the taxable incident these vested stock options could cause if they remained part of his estate.
This client’s concern is a common one among corporate executives. While the 2018 tax reform has loosened up the estate tax laws and limits, executive stock options and equity compensation plans can still have a major impact on your taxable estate. That’s why I want to share with you one estate planning strategy for corporate executives with equity compensation plans: gifting stock options. This is a strategy that, with the help of an expert executive financial advisor, could allow your family to live out the legacy you helped create for them through your years of hard work and dedication, while minimizing the amount you paid to the IRS.
Gifting Your Stock Options as an Estate Planning Strategy for Corporate Executives
Gifting or transferring your stock options sooner rather than later to the person or people you want to ultimately receive them can help avoid excessive taxes when your estate is settled. Chances are, as a top-level executive, you will have accumulated an estate sizable enough that it will encounter taxation in some way, shape, or form.
Chances are also high that your stock options have appreciated over time if you have worked for a growing, profitable company for more than a couple of years. The reality is, allowing yourself to be exposed to some minor taxation now on the transfer of your stock options can be greatly beneficial in the long run for your family and for your estate overall.
When it comes to gifting your stock options, there are few important points to know:
- When you gift or transfer your stock options, you are giving the recipient the option to exercise at whatever time they see fit, unless your employee stipulates otherwise.
- The stock options fall under the tax-free gift amount of $15,000 per person or $30,000 per married couple. Anything over that amount in one given year is held against the lifetime gift tax exclusion. This amount is now currently $11.2 million per person, up from $5.5 million per person last year thanks in part to the recent tax reform.
- The only major taxable concern with this strategy is the compensation element, which is the difference between the exercise price and the current market value of the stock when the recipient exercises the options. The exercise price was given to you by your employer when you received the stock options. This is the price at which the recipient can purchase the company stock when they choose to exercise your options. The recipient will then own the stock outright with a cost basis starting at the market value of the stock at the time they exercised the options. You—not the recipient—will be accountable for the income tax owed on the compensation element.
What to Consider Before Gifting Your Stock Options
Knowing what to consider before you implement a tax strategy to gift your stock options is important and can ultimately save you and your family a lot of money and heartache in the long run. This is why I always recommend you work with a trusted estate planning attorney in conjunction with an experienced executive financial advisor for these and other estate-related scenarios. They’ll know the important questions you need to address when considering gifting your stock options, such as:
- Are your options transferable? One of the first things you need to do if you’re considering gifting or transferring your stock options is to confirm they are transferable. Some companies don’t have this wording in their agreement with their employees. Some companies actively don’t want to allow options to be transferred. However, other companies may have just overlooked it when putting together their document, so it is always best to ask. This is something the company can amend if it agrees that the ability to gift stock options should be available to employees.
- Who will receive your gifted stock options? Most equity compensation plans stipulate that you are only allowed to gift your stock options to immediate family or to a trust or other legal entity owned solely by your immediate family. Most executives I work with choose to gift to their family members. If you have someone else in mind, however, you will want to consult with your employer about what is allowed under your plan.
- Are your stock options fully vested? Every company is different in their vesting schedules, which is why it is important for you and your advisor to fully understand your company’s schedule and how it relates to your unique situation. Typically, most companies will not allow the recipient of your stock options to exercise those options until you have become fully vested. Some companies will not even allow you to transfer those stock options until you are fully vested. So again, make sure to consult your employer documentation regarding your equity compensation plan before making planning decisions.
- How will you pay income tax on the compensation element? You will pay income tax when the stock options are exercised. There is no way around it, so you need to plan accordingly. If you know roughly when the person will be exercising the stock options you gifted them, you could predict an approximate market value of the stock and calculate an estimate of the income tax you will be responsible for paying. Your employer may take the tax from your regular income, or you may need to pay it at the end of the year. Either way, having a plan will ensure you are not caught off guard.
- What does your company require? Lastly, consider the requirements your company has set in regards to the corporate stock owned by executives. Many companies have clearly defined or highly implied guidelines requiring executives to own a certain percentage or dollar amount of company stock. The last thing you want to do is step outside of these guidelines unknowingly. Make sure to review these guidelines with your financial advisor prior to making any decisions.
When it comes to estate planning for corporate executives, equity compensation plans can make a large impact. By knowing what to consider and asking the right questions with the help of a financial advisor, you can design a cohesive strategy to address this area of your estate. As an executive that has put in countless work hours over the years, you should feel confident that you will be able to leave a legacy for your family. Gifting your stock options could be one strategy to help you do just that.
K. Wade Carpenter, CFP®, AIF®, ChFC®, CLU®, is an innovative wealth manager serving corporate executives and entrepreneurs from coast to coast. Throughout his more than 25-year career, Wade’s focus on C-level clients has made him a top strategist for integrated asset allocation and equity compensation management. He has developed estate planning strategies for corporate executives with equity compensation plans. For more information on how Wade and the Carpenter Team can advise you on estate planning for corporate executives, reach out today for a complimentary consultation.
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