NOTHING IN THIS DOCUMENT SHOULD BE CONSTRUED AS FINANCIAL ADVICE, IT IS THE OPINION OF THE AUTHOR WHO IS NOT A FINANCIAL ADVISOR
CAN’T STRESS THAT ENOUGH LADS, THIS IS ALL BASED ON MY EXPERIENCE AND CIRCUMSTANCES
So, you started in a new job and you get these weird things called Options or Stock Options. What are they and what do I need to do? I’m going to make some basic assumptions, entirely based on my own experience and circumstances.
What are Options?
Stock options are an incentive given by your company to work for them or stay working for them. They are, in essence, lottery tickets. The price of the stock may go up, it may go down, or they may not change in price at all – this price is usually set by the board of directors during their board meetings. Often time your company will be put into a “bucket” tracking other, publicly listed, companies to give a rough guide as to what the option price “should” be.
They are different from “Reserved Stock Units”, which are given by (usually) public companies to their employees. Options are given by privately held companies, usually startups. By excising (aka buying) your options, you own a portion of the company. Until you buy your options, you do not own part of the company.
How many options do I get?
This depends on the company. During the salary negotiation phase, you should ask and negotiate how many you will get. Always negotiate for more – think about lottery tickets, the more you have the more you are likely to win. It costs the company, monetarily, nothing to give you more as investors buy a different kind of stock at a much higher rate for fancy things like board seats.
- Options – your stock options
- Options grant – a document given to you by the company that explains the terms of the options scheme
- Vesting schedule – the amount of time, listed in your options grant, that it takes for you to be allowed to buy all your options (usually 4 years)
- Vesting cliff / cliff – the minimum amount of time you need to be in the company in order to excise your options (usually 1 year)
- Strike Price – the price, per option, listed in your options grant – e.g. $1 per
- Fair Market Value (FMV) – the price, per option / share, of the current value of the stock – e.g. $2 per
- Excise / Exercise – You buying your options
- Pre-excise / pre-exercise – You buying your options in advance of them vesting fully
- RTSO1 – The form you need to fill out and send to revenue, along with a cheque, when you excise your options
- Capital Gains Tax / CGT – The tax you need to pay revenue when you sell your shares
Alice starts work in Setec Astronomy – a pioneering leader in encryption technologies. She earns 60,000 EUR a year, and got 1000 options when she joined vesting over 4 years with a 1 year cliff. The strike price is $1 per option. At the end of her second years in the company, Alice decides to “buy” her vested options.
Since Alice has decided to buy only her vested options, she can buy 500 of them (at 1000 options vesting over 4 years, she vests 250 options a year). The current fair market value is $3 per share / option.
A few things happen at this point. Alice will, likely, be asked to sign an NDA by the company in order to see their abridged financials. Since the company financials are very sensitive in a startup, she will likely not be allowed keep a copy of them. Showing the financials is a requirement of a number of companies and stock options schemes due to legal regulations to allow the employee to make an informed decision. Alice should engage with a financial advisor to discuss if excising her options are in her best interests given her circumstances. Her options are listed in USD, but she is an Irish employee and pays taxes in EUR. She decides to buy 500 options.
Alice will need to write two cheques – one to the company to excise her options, and another to the tax man. Below are the calculations needed for these cheques.
Alice pays the company the strike price listed in her options grant times the number of options. This is very simple to calculate
500 options @ 1 USD per option = 500 USD
Alice’s company has an Irish office, and will accept the 500 USD if converted into EUR and paid to the Irish legal entity of Setec Astronomy. Alice needs to find the 0% currency fee for USD/EUR on the day of excise. A commonly used online tool is https://www.oanda.com/currency/converter/ . At the time of excise, 1 USD = 0.85833 EUR.
Alice writes a cheque to Setec Astronomy Ireland Ltd for 429.167 EUR
This is where things get a bit more complicated. Her strike price of 1 USD per remains the same, but the FMV is 3 USD per. On paper, Alice has made a taxable gain of 2 USD per option.
500 options @ 3 USD per = 1500 USD
500 options @ 1 USD per = 500 USD
Taxable gain = 1000 USD = 858.334 EUR
The tax man will take the “top marginal rate” and apply it to this 858.334 EUR. At the time of writing, this is 52% . This makes the tax she owes to Revenue 446.33368 EUR. Under the RTSO1, she will pay to the nearest euro – so 446 EUR. She MUST file an RTSO1 within 30 days and include a cheque for 446 EUR at the same time to her local tax office. She MUST also file a tax return at the end of the tax year, which is very uncommon for an Irish PAYE earner. You can write off the ex-VAT cost of an accountant to file for you.
In total, excising Alice’s options cost her 875.17 EUR. We now call these 500 excised options “shares”.
Fast forward another 2 years, Alice decides to sell her shares. If the company is still not publicly listed, she has two options – sell back to the company or go on the “secondary market”. She will, likely, make more money on the secondary market however there might be a clause in her options grant that states that Setec Astronomy gets the “right of first refusal”. The RoFR means the company must be the first entity offered the shares. Either way, her taxable gains are similar, so let us pretend a RoFR is in place and the company exerts its RoFR. These calculations are the same even if she sells on the private market, which we’ll get into in a bit.
The current FMV is now 100 USD. Alice still has her 500 shares.
Convert this 50000 USD into EUR, so let’s pretend 42916.5 EUR (again, use a 0% currency fee on the day of sale). Minus the cost of buying the shares from the company, the income tax you already paid under the RTSO1 and any other deductibles gives us a taxable gain.
The only difference between a RoFR and selling on the public market (secondary or otherwise) is that the broker takes their cut. Their cut is a deductible, and often they will just hand you a cheque for the full amount minus their fees.
This is the annoying part. You MUST file with Revenue and pay the CGT. The money you get either from the company or from a broker is the full amount, so don’t go spending it all. Get a decent accountant to file for you, and as an added bonus their fees are tax deductible – so are solicitors fees if you had to engage with one for whatever reason. Now you CAN do this yourself with a Form 12 but it might make more sense to chat with an accountant to sort all this out for you seeing as their fee is a deductible.
To drastically reduce your tax liability, it might make sense for you to dump a portion of the money you make into your pension. You’ll see need to pay the CGT in full, but you can reclaim the pension contribution relief later in the year to help offset the burden. This is a very smart thing to do if you don’t actually need the money right now as the amount you can put in can be rather substantial – such as 20% of your earnings for the year if you’re in your 30s.