Dealing with Company Buyouts – Part 3: Stock Options

PART 3: Stock options and restricted stock

Mergers and acquisitions are a common business strategy and often result in a realignment of talent among mid- and upper-tier executives. Many jobs are eliminated, and severance packages are offered. If your company has recently been acquired or will merge with another company, it’s wise to consider taking immediate action to preserve the compensation you have earned. In addition, it makes sense to develop a strategy designed to strengthen your financial future.

In our six-part series on the potential impact of a company buyout, we’ll discuss several important issues related to your finances.

In this article, we look at stock options and restricted stock.

Stock options

A change of control in your company could mean that thousands of unvested shares of common stock will now be fully vested. The gain in your stock options may become the largest asset on your balance sheet. This also means a large part of your overall net worth is likely tied to company stock. We are often asked, “How much of my net worth should I hold in a concentrated stock position?” By the time you’ve entered the “withdrawal phase” of your life, we think you should typically hold enough diversified assets to cover core living expenses and taxes. Above this core level, we believe concentration in a single stock position doesn’t pose as much risk to your financial strategy. We recommend having a predetermined strategy for your stock options, as it can provide peace of mind and the confidence to make these critical decisions.

This exercise strategy will likely need to change given the merger or acquisition, as your timeframe to exercise stock options is often shortened. The acquiring company may require you to exercise the options within three to six months of the merger or your termination date. This could cause your income to skyrocket for the current tax year.

Next, you may be able to convert these shares into the acquiring company’s stock. This means the number of shares and the price per share will change after the merger. Additionally, if you remain at the new company, a new stock option plan may be created, so any new options you’re granted could have a different framework. This may affect provisions around retirement, death, disability, vesting and expiration periods.

Since stock option proceeds are subject to income tax upon exercise,¹ we recommend your exercise strategy include income tax planning. For example, perhaps you can exercise a portion of your options next year while staying just under the top marginal tax rate. If you can stay out of the top tax bracket when exercising options, especially in the year you receive severance pay, this may also save taxes on other parts of your financial picture, such as dividends, interest and capital gains from your brokerage accounts. Also, if you’re in a higher federal tax bracket than the percentage of federal tax being withheld on your exercised non-qualified stock options, we suggest holding back some cash from your non-qualified stock option proceeds to pay for the additional tax due.

Incentive stock options are taxed differently and subject to the Alternative Minimum Tax calculation.² Although income taxes are not withheld upon exercise of an incentive stock option, consult with a tax professional to understand your tax liability when filing your tax return that year.

Stock option income can play a significant role in your wealth accumulation and cash flow strategy. We believe it’s important to have a plan in place, especially if you face a limited window to exercise your options.

Restricted or performance-based stock

The merger or acquisition may require that this form of compensation be cashed out. If so, there will be a significant impact on income taxes due because you’re receiving this income earlier than expected and all at once.

Since we see executives often hold much of their wealth in their employer’s stock, being forced to liquidate unvested restricted stock will lower the concentration of stock held in just one company. This could have an impact on your overall investment strategy, as your allocation to stocks has declined, and your allocation to cash has ballooned. You may wish to rebalance your portfolio accordingly.

If your vested company stock converts to shares in the new organization, be sure to track any adjustments to the cost basis, as this will impact your taxes when you sell the stock. There may be a one-for-two conversion of the old stock into the new stock, with cash received from fractional shares. Determine your cost basis for each share of stock you own before the merger, and note any adjustments to the cost basis for your new stock after the merger. Depending on how long you’ve held your company stock, the gain will be taxed as either a short-term capital gain at your top marginal tax bracket or a long-term capital gain. And don’t forget about state income taxes.

Finally, if you’re staying with the new company, the new restricted stock plans could be quite different. For example, stock plans based on performance may have different measures than those at your old firm. It’s also possible that executives at your level may not qualify for stock grants.

We’re ready to support you

To make wise decisions when facing a corporate restructuring, we believe you need to understand all the aspects of how this significant change may impact your finances now and in the future. Our team has the experience and expertise to develop your personal strategy, helping you make appropriate moves regarding your separation or transition package and, more importantly, gain clear insights into the potential impact on your overall financial well-being.

Other topics in this series:

• Severance, deferred compensation, investments
• 401(k) and Supplemental 401(k)
• Pension plans
• Insurance planning
• Tax and estate planning

¹ https://www.investopedia.com/articles/active-trading/061615/how-stock-options-are-taxed-reported.asp
² https://www.investopedia.com/terms/i/iso.asp

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