Probate & Trust Law Section Conference Manual ... - Minnesota CLE

Stock Options: Sales, Gifts, &
Transfers
This outline covers planning for stock
options, including income, estate and gift tax
planning, from the perspective of the employee or
option holder. It does not delve into the
considerations for the issuing corporation, nor does
it attempt to address the issues arising in other legal
disciplines like securities law. From a tax
standpoint, options can be divided into two broad
groupings – compensatory and non-compensatory
options. Unless you’re involved with active
sophisticated investors, the first group is usually the
more significant for advisors.
A. Introduction
Compensatory options are those granted “in
connection with the performance of services.” They
are generally governed by Section 83, 1 with the
exception of incentive stock options, which are
governed by Sections 421 and 422 generally.
Compensatory options are limited to “call” options,
which grant the holder the right to purchase stock
from the issuing corporation. A call option permits
the holder to purchase stock from the company at a
fixed price (the “strike price” or “strike”) usually at
any time during a fixed period of time specified in
the option grant.
Non-compensatory options include both
“put” and “call” options purchased in the
marketplace or in a private transaction unconnected
with the provision of services. They comprise a
separate world commonly referred to as
“derivatives” that focuses on hedging, speculation
and income enhancement. Non-compensatory
options occupy a parallel universe with totally
different rules not addressed in this paper.
Compensatory options can be divided into
two subgroups – incentive stock options (ISOs),
sometimes referred to as qualified or statutory stock
options, and all other compensatory options, which
are usually referred to as non-qualified or nonstatutory
stock options (NQSOs). These two
subgroups and the related planning for holding,
1 All section references are to the Internal Revenue Code
of 1986, as amended, unless otherwise indicated. Any
reference to the “Code” shall mean the Internal Revenue
Code of 1986, as amended.
exercising and transferring them are the subject of
this paper. 2
B. Lifetime Gifts of NQSOs
When advising a client concerning the
various strategies that can be employed for options,
particularly for estate planning purposes, it is critical
to determine whether the particular options are
transferable. If they are ISOs, they cannot be
transferable except at death. If the options are
NQSOs, they may not be transferable during life as
a matter of company policy. 3 Even when NQSOs
are transferable during life, the transfer privilege is
often limited to members of the employee’s family,
family-controlled entities and sometimes charities.
There are a number of strategies that can
yield significant transfer tax savings, but they all
involve lifetime transfers. Hence, it is important to
review the particular grant instrument(s), and the
plan(s) under which the options were issued, in
order to determine the nature of any transfer
restrictions. In the ensuing discussion, it is assumed
that the particular options are transferable to family
members, family-controlled entities and charities.
1. Gifts to Charity. When a client wants to
provide financial support to a charity, advisors often
advise that such support should be funded by
transferring low-basis assets. Stock of publiclytraded
companies is particularly useful for this
purpose. Transferring public stock is relatively
easy, and it can be quickly and cheaply converted
into cash by the charity, without the payment of any
tax.
From the donor’s perspective, donating lowbasis
stock is more tax-efficient than funding the
contribution with cash. The deduction amount is
usually the same in both cases, but transferring lowbasis
stock affords the additional advantage of
eliminating any tax on the unrealized gain, at least if
2 The ensuing discussion will focus on common stock
options issued by public companies, but it is generally
applicable to private company common stock options as
well.
3 Tax considerations also influence this decision
somewhat. Where NQSOs are freely transferable, they
can be treated as having readily ascertainable FMV, thus
exposing them to immediate taxation upon grant. See
Regs. Section 1.83-7(b).