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What Is It?

A stock option is a written offer from an employer to sell stock to an employee at a specified price within a specific time period. A stock option can be a valuable form of additional compensation to your employees, because it provides your employees with the benefits of company ownership along with potential tax benefits. When you offer your employees stock options, you provide them with the opportunity to purchase shares of your company's stock at a price that may be below the stock's fair market value (FMV).

If your employee exercises the stock options, he or she purchases the shares at the lower option price, resulting in a windfall to your employee if the stock's value increases. Since stock options usually last for a long period of time (e.g., 10 years), your employee does not have to sell or purchase the stock when it would be economically unwise. As a result, your employee can avoid economic loss. As for taxation of the stock option, the employee is usually not taxed when you offer him or her the stock option. Instead, taxation is deferred until the time the employee exercises the option. There are two types of stock options that you can offer to your employee: incentive stock options and nonqualified stock options, also known as nonstatutory stock options. This discussion will focus on nonqualified stock options.

Nonqualified Stock Options (NQSOS)

In General

Unlike an incentive stock option (ISO), which must meet certain requirements under Internal Revenue Code Section 422 to achieve its tax-favored status, a nonqualified stock option (NQSO) is a stock option that either does not meet statutory requirements or specifically states that it is an NQSO. Although an employee who participates in an NQSO is not entitled to the same tax benefits as an ISO, it can still be an attractive alternative to an ISO, because it does not have to follow the requirements of Internal Revenue Code Section 422. As a result, an NQSO plan is an extremely flexible form of employee compensation, allowing you to configure the plan to meet both your and your employees' needs.

Taxation of Nonqualified Stock Options

Generally, if an option does not have a readily ascertainable FMV at the time it is granted to the employee, it is not treated as taxable income to the employee at the date of the grant. Instead, the option is treated as taxable income when your employee purchases the option shares. The amount of taxable income is the difference between the FMV of the shares at the date of purchase and the option price (the amount your employer pays for the shares). As for employer tax benefits, you do not receive a deduction when the option is granted. Instead, you receive a deduction in the same year the employee has taxable income as a result of exercising the option. The amount of the deduction is the same as the amount of the employee's taxable income.

Example(s): Jeff was given an option in Year 1 to purchase 500 shares of Acme, Inc. at the current market price of $50 per share. Jeff could exercise the option at any time during the next three years. In Year 2, he purchased 250 shares for $12,500 (250 x $50). The FMV of the shares at the time of purchase was $18,750 (250 x $75), so Jeff has $6,250 ($18,750 - $12,500) in taxable income. In addition, Acme, Inc. can deduct $6,250 for Year 2. If the option does have a readily ascertainable FMV at the time of the grant, it is taxed at that time, while the employer receives a corresponding tax deduction.

Tip: Generally, an option has a readily ascertainable FMV if the option can be traded on an established market.

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IRC Section 409A

IRC Section 409A contains complex rules that govern nonqualified deferred compensation (NQDC) plan deferral elections, distributions, funding, and reporting. If a NQDC plan fails to satisfy Section 409A's requirements participants may be subject to current income tax, as well as an interest charge and 20 percent penalty tax. Nonqualified stock options plans may be subject to IRC Section 409A. month if you retire early, over your remaining lifetime you may receive more than someone who retired late or at normal (full) retirement age. For example, if you retire at age 62, you will receive 48 more benefit checks than someone who retires at 66. This may add up to a substantial amount of money that will be difficult to compensate for even with an increased benefit check. On the other hand, you may want to work as long as possible because you need to provide for your family. In addition, if you postpone receiving your Social Security retirement benefit, you will increase your benefit substantially because your monthly earnings may increase and you will receive a late retirement credit.

Tip: When deciding at what age you want to begin receiving Social Security retirement benefits, consider other retirement benefits you may receive as well. For example, you may be able to retire at age 62 (or earlier) and begin receiving a pension from your employer as well as a Social Security supplement that will pay you a benefit equivalent to what you would receive from Social Security until you reach normal (full) retirement age. Consider, too, your tax situation, and how your decision will affect your spouse or dependent family members.

How Much You Earn During Your Lifetime

Since your retirement benefit check will be based on your average monthly earnings, earning more during your lifetime is one way to maximize your Social Security retirement benefit. The indexed income you receive in a certain number of your highest earnings years (usually 35) is added up and divided by the number of months that elapsed during those years. The result is your AIME amount. Then, a benefit formula will be applied to determine your PIA upon which your monthly benefit will be based.

You can't increase your monthly benefit by changing the formula used to calculate it; that formula is determined by law. However, you may increase your monthly benefit by increasing your AIME amount. You may also wish to increase your AIME to ensure that you will be eligible for minimum Social Security benefits in the event that you've worked only sporadically in a job covered by Social Security.

How Much You Earn After You Retire

Part of your Social Security retirement benefit is not payable if you're under normal (full) retirement age and have earned income in retirement in excess of a certain amount. This amount is known as the retirement earnings test exempt amount. In 2019, you can earn up to $17,640 if you have not yet reached normal (full) retirement age or up to $46,920 during the year you reach normal (full) retirement age (up to, but not including the month you reach normal (full) retirement age). If you make the same as or less than these amounts, your Social Security retirement benefit won't be reduced. Once you have reached your normal (full) retirement age, your earnings in retirement won't reduce your Social Security benefit.

So to optimize your benefit, you can calculate how your earned income might affect your benefit and consider postponing any earned income in retirement until you reach your normal (full) retirement age. However, keep in mind that the benefit reduction is based on your actual earnings and is not permanent; your monthly benefit is reduced starting in January of the year following the year you had excess earnings and will be reduced until the excess earnings are used up. Additionally, if your monthly benefit is reduced in the short term due to your earnings, you'll receive a higher monthly benefit later. That's because the Social Security Administration (SSA) recalculates your benefit when you reach full retirement age, and omits the months in which your benefit was reduced.

Get the Information You Need To Plan Your Strategy

Before you can plan a strategy to optimize your retirement benefits, you need to find out how much you might receive. You can use the SSA's Retirement Estimator tool available on the SSA's website ( ssa.gov ) to estimate your future Social Security benefits based on your earnings record. You can also visit the SSA website to sign up for a my Social Security account and obtain a copy of your Social Security Statement. Your statement contains a detailed record of your earnings, as well as estimates of retirement, survivor, and disability benefits. If you're not registered for an online account and are not yet receiving benefits, you'll receive a statement in the mail every year, starting at age 60.

 

 

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

 

The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that specializes in transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.

 

The Retirement Group is a Registered Investment Advisor not affiliated with FSC Securities and may be reached at www.theretirementgroup.com.

 

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