The exercise price of the new option issued in exchange for the cancellation of the old option should not be less than the fair market value of the underlying share at the date of the exchange. Where those conditions are met, a special rule in the Income Tax Act Canada deems the old option not to have been disposed of and deems the new option to be the same options as, and a continuation of, the old option.

When Your Stock Options Are Underwater

A company could also reprice an option by reducing its exercise price, without requiring an exchange of the old option for a new option provided that the repricing could have been achieved through such an option exchange with the same tax results. However, if other changes in addition to reducing the exercise price are made to the options e. The strategy regarding the repricing will have to take into account these new measures and their impact for the employees, but also to the employers.

In the United States, the repricing of an incentive stock option ISO is considered a modification akin to a new grant. The gain on exercise of a repriced ISO can only be treated as a capital gain if the shares are held for at least two years from the date of the repricing and more than one year from the date of exercise.

If an option is repriced in a year that the option vests, a company must count both the original option and the new, repriced option in making this calculation. Prior consent of ISO holders should be obtained and the repricing offer should be open for less than 30 days. For non-qualified stock options, any repricing must be done in a manner that complies with Section A of the United States Internal Revenue Code the Code so as not to trigger adverse tax consequences to the option holder. The repricing should be a single repricing and not indicating a pattern or practice, and the new exercise price must be at least the fair market value of the underlying share on the date of repricing.

The repriced option is treated as a new option under Section A of the Code. No other material modification should be made that would tend to enhance the option benefit or provide for further tax deferral for example, the expiry date of the option should not be extended.

For companies that cannot or prefer not to undertake option repricing, consider the following alternatives:. Companies may also consider awarding additional stock options to optionees without cancelling outstanding options. If the exercise price of each additional option is at least equal to the market value of the underlying share at the time of the grant, the new option will provide its holder with a greater potential for gain than will existing options.

However, this type of expanded stock option program will also exacerbate both dilution and overhang, and the company should be comfortable there is sufficient room in its share reserve. Shareholders of a TSX- or TSX-V-listed company need not be asked to approve additional awards, unless an increase in the number of shares reserved for issuance under the existing option plan is required or the additional grants to insiders would cause the company to exceed the insider participation limits contained in the plan.

However, if shareholder approval is needed, the company should be prepared for possible resistance from institutional investors. In deciding whether to issue additional options to employees, companies should also take the following into account:. An alternative to stock option repricing involves cancelling existing stock options in return for grants of restricted share units RSUs or restricted stock with the same theoretical value as the cancelled options.

Restricted stock is stock that is generally subject to a substantial risk of forfeiture at grant but that will vest upon the occurrence of certain time or performance-based conditions. RSUs are economically similar but involve a deferred delivery of stock or cash at a time that is concurrent with, or after, vesting.

As discussed in further detail below, however, this alternative will have unfavourable tax consequences for the individual. As a result, there is less dilution and lower equity overhang than in a repricing exchange of options. While some companies may seek shareholder approval of their RSU exchange programs, the TSX only requires an issuer to obtain approval of a full-value award plan if treasury shares are reserved for issuance under it.

Cash-only arrangements or those that are only funded by securities purchased in the secondary market do not require shareholder approval. However, proxy advisory firms consider the substitution of other equity awards in exchange for options to be equivalent to a repricing of stock options. Accordingly, it is preferable to consider awarding RSUs or restricted stock as additional incentives without cancelling outstanding options.

With respect to Canadian tax considerations, as a general rule, underwater stock options cannot be cancelled and exchanged for either restricted stock or RSUs without triggering a taxable benefit to the holder in an amount equal to the value of the restricted stock or RSUs. Accordingly, in such circumstances, companies should issue restricted stock or RSUs in addition to the existing, underwater stock options and not in exchange for the cancellation of the options. Moreover, because the value of restricted stock is taxable to the employee when the stock is issued albeit subject to a possible discount to reflect the impact of the restrictions on the fair market value of the shares , RSUs are more commonly used in Canada.

Care should be taken not to exceed the relevant three-year period where RSUs are awarded in connection with underwater options that relate to services rendered more than three years prior to the award. In the United States, restricted stock is often a desirable replacement award because the share can be issued to the holder, but the value of the share is not included in income until it vests. However, the individual can choose to file an election to incur income taxation on the award date so that all gain after the award date and after income inclusion can be treated as capital gain.

Make Sure You Understand Any Stock Options You May Have

How do employees come up with the cash to exercise the options and buy the stock? You can use savings, rollover proceeds from another stock sale, or borrow from a brokerage account and pay it back immediately. Timing is important, however. If the stock price is trading lower than the grant price, the options are said to be underwater. Exercising options is useless if the employee can buy shares of the company stock for less on the open market.

Most employees get NSOs, which are priced at a discount and taxed at ordinary income tax rates. A tax hit occurs once the options are exercised, so you pay either income tax or capital gains tax depending on whether your option is qualified, based on the grant price. Once you exercise the options, you can sell the shares after a short waiting period, or hold onto the shares and wait for the stock to increase further before selling. Some investors hedge their bets by doing a bit of each. Once reserved only for the executive team, stock options became a popular form of compensation during the tech boom in the late s.

Back then, there were many tales of stock option success, and certain types of employees were looking for a sense of ownership in their workplace that went beyond the paycheck. By , so many options were underwater that they lost some of their appeal among the corporate masses. But in the world of start-ups, enough people got very wealthy from stock options that they remain a great tool for attracting early-stage talent.

The value in the stock option lies in the opportunity to profit if the stock price goes up in the future. If the stock price is greater than the grant price a good market , your stock option has a current value. You also have the right to do this 1, times 1 time for each share. If the future market price is below the grant price, you would choose to do nothing.

This short example is a simple and watered-down version of how employee stock options work and how you may make money if you are lucky enough to own them. But it gets more complicated from here. When your employer issues your employee stock options, you should receive a document that details the specifics and rules around your options. A quick note on one of these terms: A vesting schedule is used by an employer to help keep you working for the company.

They provide you a future right to something that may be valuable to incentivize you to stay to at least that point in the future. If the stock option does have value, that value may keep you working at your company until you can take advantage of your stock option right. In addition, the opportunity to generate wealth via a stock price that goes up may keep you motivated along the way. These four terms will provide you enough ammunition to know what you own, when you can use it, and when it goes away.

Beyond these key points, the documentation around your options should also spell out regarding what happens to your stock option if you terminate employment via death, disability, and retirement. Other details will cover what happens if you leave your company or if your company merges with another. Generally speaking, they both have identical features as discussed above.

Stock Options Are Worthless Until Sold

However, incentive stock options and non-qualified stock options are materially different. Incentive stock options ISOs are employee stock options that may allow for a potential tax advantage. Because of this advantage, they are often seen as superior to their non-qualified stock option cousins. ISOs make it possible for any gain from the strike price, to exercise price, to the final sale price to be eligible for preferential long-term capital gains treatment.

To achieve this preferential tax treatment, however, you might be subjected to alternative minimum tax and must meet various holding requirements. Non-qualified stock options are much simpler. There is no alternative minimum tax, and no holding period requirements. The gain from the strike price to the exercise price is taxed as ordinary income, and flows directly through to your W2. If you have stock options that have value, that means the prevailing market price is above the strike price of the option.

The decision to exercise your option can be for many reasons ,. When you exercise your employee stock options, you will be subject to income tax.