Stock Option Exercise Methods and Release Methods
There are several methods optionees can use to pay for the cost of the shares and related taxes: cash, loan, stock swaps, same day sales, sell to cover, and SAR exercise.
Here's a brief discussion of each of these methods with examples illustrating how they work:
Cash
At the time of exercise, the employee is required to pay the total option price plus any withholding taxes due to the organization.
Example 1: Cash ISO Exercise
On August 22, 1998 an optionee was granted an ISO option to purchase 500 shares vesting in five annual increments beginning one year from the date of grant. The option price was $3.40 per share. On November 1, 1999 the optionee exercised the stock option for the first 100 shares. The FMV on the date of exercise was $12 per share. The calculation is:
| Calculation Step | Example |
|---|---|
|
Grant Price x Shares Exercised = Option Cost |
$3.40 x 100 shares = $340 |
|
Exercise FMV x Shares Exercised = Exercise Value |
$12 x 100 shares = $1,200 |
|
Exercise Value − Cost of Shares = Tax Preference Income for AMT |
$1,200 - $340 = $860 |
No withholding taxes are calculated at exercise. Thus the optionee owes the company the cost of shares ($340.00) and receives 100 shares.
Example 2: Cash NQ Exercise
On September 22, 1998 an optionee was granted an NQ option to purchase 500 shares vesting in five annual increments, beginning one year from the date of grant. The option price was $3.40 per share. On November 1, 1999 the optionee exercised the stock option for the first 100 option shares. The FMV on the date of exercise was $12 per share. The optionee is a California resident for income tax purposes. The calculation is:
| Calculation Step | Example |
|---|---|
|
Grant Price x Shares Exercised = Option Cost |
$3.40 x 100 shares = $340 |
|
Exercise FMV x Shares Exercised = Exercise Value |
$12 x 100 shares = $1,200 |
|
Exercise Value − Cost of Shares = Ordinary Income |
$1,200 - $340 = $860 |
Taxes are based on your setup and whether you are integrated with Payroll for North America. For example, taxes might be calculated as follows:
| Calculation Step | Example |
|---|---|
|
Federal |
$860 x 28% = $240.80 |
|
State |
$860 x 6% = 51.60 |
|
Social Security |
$860 x 6.2% = 53.32 |
|
Medicare |
$860 x 1.45% = 12.47 |
|
SDI |
$860 x .5% = 4.30 |
|
Total Taxes Due |
$362.49 |
Thus the optionee owes the company the sum of the cost of shares ($340.00) and the total taxes due ($362.49). The optionee pays the company $702.49 and receives 100 shares.
Loan
Loans are another form of a cash exercise. They typically require a loan agreement and a promissory note. You can select Loan as a payment method at the time of exercise, but all other aspects of loan administration are handled outside of the Stock Administration system.
All aspects of processing the exercise with the payment method of Loan are the same as those involving the payment method of Cash.
Stock Swaps
When optionees elect to exercise stock options by means of a stock swap, they are exchanging shares they already own for option shares. The shares exchanged are usually valued at the fair market value of the company's stock on the date of exercise.
In the case of a stock swap, the ordinary income or Tax Preference Income for AMT is calculated in the same manner as a cash exercise. If an optionee exercises a non-qualified stock option, ordinary income is recognized on the option shares acquired and taxes may be withheld. The shares required for the swap/trade are cancelled and sent back to either the stock plan or the treasury, according to the stock option plan rules.
The formula for calculating stock swaps is:
Cost of Share = Shares Exercised x Grant Price
Shares Required for Swap = Cost of Shares/Swap FMV
Example 1: ISO Stock Swap
An optionee was granted an ISO to purchase 500 shares vesting in five annual increments beginning one year from the date of grant. The option price was $3.40 per share. On November 1, 1999 the optionee exercised the stock option for the first 100 option shares via a stock swap. The FMV for both the exercise and swap was $12 per share. The swap rounding rule specifies to round down. The calculation is:
| Calculation Step | Example |
|---|---|
|
Cost of Shares |
100 x $3.40 = $340 |
|
Shares Required for Swap |
$340/$12 = 28.333 |
|
Swap Value |
$12 x 28 = $336 |
|
Additional Cash Required |
$340 - $336 = $4 |
|
Tax Preference Income for AMT |
($12 - $3.4) x 100 = $860 |
|
Total Shares Exercised |
100 |
|
Shares Required for Swap |
28 |
|
Net Shares Issued |
72 |
This assumes constructive delivery of swapped shares. The optionee owes the company $4.00 and receives 72 shares. The number of shares cancelled is 28. The cost basis for the shares issued becomes the amount due to the company divided by the net shares issued. In the above example the Cost Basis per share would be $.055555.
Example 2: NQ Stock Swap
If an optionee exercises a non-qualified stock option, ordinary income is recognized on the option shares acquired and taxes may be withheld. The shares required for the swap/trade are cancelled and sent back to either the stock plan or the treasury, according to the stock option plan rules.
On September 22, 1998 an optionee was granted an NQ option to purchase 500 shares vesting in five annual increments beginning one year from the date of grant. The option price was $3.40 per share. On November 1, 1999 the optionee exercised the stock option for the first 100 option shares using a stock swap and trade for taxes. The FMV for both the exercise and swap was $12 per share. The swap rounding rule is set to round down. The optionee is resides in California and has not met the limits for Social Security or SDI. The calculation is:
| Calculation Step | Example |
|---|---|
|
Cost of Shares |
100 x $3.40 = $340 |
|
Shares Required for Swap |
$340/$12 = 28 |
|
Value of Swapped Shares |
$12 x 28 = $336 |
|
Additional Cash Required |
$340 - $336 = $4 |
|
Ordinary Income |
($12 - $3.4) x 100 = $860 |
Taxes are calculated as follows:
| Calculation Step | Example |
|---|---|
|
Federal |
$860 x 28% = $240.80 |
|
State |
$860 x 6% = 51.60 |
|
Social Security |
$860 x 6.2% = 53.32 |
|
Medicare |
$860 x 1.45% = 12.47 |
|
SDI |
$860 x .5% = 4.30 |
|
Total Taxes Due |
$362.49 |
The trade transaction is:
| Calculation Step | Example |
|---|---|
|
Shares Required for Trade |
$362.49/$12 = 30 |
|
Value of Trade |
12 x 30 = 360 |
|
Additional Cash Required |
362.49 - 360 = 2.49 |
Recap of Exercise Transaction:
| Transaction Description | Example |
|---|---|
|
The total shares need in the swap |
2830 = 58 |
|
Optionee owes the company |
4+2.49 = 6.49 |
|
Total shares exercised |
100 shares |
|
Total shares Returned to Plan or Retired to Treasury |
58 shares |
|
Optionee receives |
42 shares |
This assumes constructive delivery of swapped shares.
For a tandem SAR, only the exercise of shares could use a stock swap. If the optionee exercises the SAR shares using a stock swap, the transaction would be handled in exactly the same manner as for the corresponding ISO or NQ example.
An option that allows unvested shares to be exercised before they are vested, such as an RSA, does not allow the use of a swap at the time of exercise. A trade is only allowed at the time the shares are released when payment is needed to cover tax liability that might be due.
Same-Day Sale
A same day sale is when the optionee finances the exercise of a stock option by immediately selling 100 percent of the shares exercised or released.
Example 1: ISO Same Day Sale
On September 22, 1998 an optionee was granted an ISO to purchase 500 shares vesting in five annual increments beginning one year from the date of grant. The option price was $3.40 per share. On November 1, 1999 the optionee exercised the stock option for the first 100 option shares and sold all 100 shares at $12.50 per share. The FMV on the date of exercise was $12 per share. The sale income method for the stock plan is the lesser of the FMV or the sale price. The calculation is:
| Calculation Step | Example |
|---|---|
|
Grant Price x Shares Exercised = Cost of Shares |
$3.40 x 100 shares = $340 |
|
(Lesser of FMV or Sale Price x Shares Sold) + (Shares Exercised −Shares Sold x FMV) = Exercise Value |
($12 x 100 shares) + ((100-100) x 12) = $1,200 |
|
Exercise Value − Option Cost = Tax Preference Income for AMT |
$1,200 - $340 = $860 |
Thus the total due the Company = $340.00
The company instructs the transfer agent to issue 100 shares and deliver them to the stockbroker. The company also bills the stockbroker for the cost of shares ($340.00). The optionee then receives the difference between the Total Sale Price less the Total Due Company and any brokerage fees.
Example 2: NQ Same Day Sale
On September 22, 1998 an optionee was granted an NQ to purchase 500 shares vesting in five annual increments beginning one year from the date of grant. The option price was $3.40 per share. On November 1, 1999 the optionee exercised the stock option for the first 100 option shares. The FMV on the date of exercise was $12 per share. The optionee resides in the state of California for income tax purposes. The calculation is:
| Calculation Step | Example |
|---|---|
|
Grant Price x Shares Exercised = Option Cost |
$3.40 x 100 shares = $340 |
|
Exercise FMV x Shares Exercised = Exercise Value |
$12 x 100 shares = $1,200 |
|
Exercise Value − Option Cost = Ordinary Income |
$1,200 - $340 = $860 |
Taxes are calculated as follows:
| Calculation Step | Example |
|---|---|
|
Federal |
$860 x 28% = $240.80 |
|
State |
$860 x 6% = 51.60 |
|
Social Security |
$860 x 6.2% = 53.32 |
|
Medicare |
$860 x 1.45% = 12.47 |
|
SDI |
$860 x .5% = 4.30 |
|
Taxes Due at Exercise |
$362.49 |
The total due to the organization is = $340.00 + $362.49 = $702.49
The organization instructs the transfer agent to issue 100 shares for delivery to the stockbroker and bills the stockbroker for the cost of shares and taxes ($702.49). The optionee receives the total sales price less the total due the organization and any brokerage fees.
Sell to Cover
Sometimes the optionee only wants to sell a portion of the option shares to cover the exercise cost. Many times the optionee contacts the company to have them estimate using the current FMV, the total shares that would have to be sold to cover the cost of the exercise and applicable taxes. The following examples show how these types of transactions would be handled. Example 1: NQ Sell to Cover
On September 22, 1998 an optionee was granted an NQ to purchase 500 shares vesting in five annual increments, beginning one year from the date of grant. The option price was $3.40 per share. On November 1, 1999 the optionee sells enough stock (60 shares at a sale price of $12.50) to cover the exercise of 100 shares. The optionee wants to have the remaining 40 shares issued and delivered to himself. The FMV on the date of exercise was $12 per share. The sale income method for the stock plan is set to sale price. The optionee is a California resident for income tax purposes. The calculation is:
| Calculation Step | Example |
|---|---|
|
Grant Price x Shares Exercised = Cost of Shares |
$3.40 x 100 shares = $340 |
|
(Sale Price x Shares Sold) + ((Shares Exercised - Shares Sold) x Exercise FMV) = Exercise Value |
(60 x $12.50) + ((100-60) x 12) = $1,230.00 |
|
Exercise Value − Cost of Shares = Ordinary Income |
$1,230 - $340 = $890 |
Taxes are calculated as follows:
| Calculation Step | Example |
|---|---|
|
Federal |
$890 x 28% = $249.20 |
|
State |
$890 x 6% = 53.40 |
|
Social Security |
$890 x 6.2% = 55.18 |
|
Medicare |
$890 x 1.45% = 12.91 |
|
SDI |
$890 x .5% = 4.45 |
|
Taxes Due at Exercise |
$375.14 |
The total due the company is $340.00 + $375.14 = $715.14
The company instructs the transfer agent to issue 60 shares and deliver them to the stockbroker, and issue 40 shares and deliver them to the optionee. The organization also bills the stockbroker for the option price and taxes ($702.49). The optionee receives the Total Sales Price less the Total Due Company and brokerage fees.
SAR Exercise
This method is only allowed if the option type is a tandem SAR (ISO/SAR or NQ/SAR). The underlying shares of the option are valued using the SAR FMV and the optionee is paid out the cash rights on these shares by subtracting the grant price from the SAR FMV determined on the date of the exercise. Taxes are typically due on the income at the time of the exercise for both ISO/SAR and NQ/SAR option types. Only when the individual exercises the right to the ISO shares can the preferential tax treatment be taken. The underlying shares that are used to value the cash rights are then cancelled and sent back to either the stock plan or the treasury, according to the Stock Option Plan rules specified. On September 22, 1998, an optionee was granted an ISO/SAR to purchase 500 shares that vests in five annual increments, beginning one year from the date of grant. The option price was $3.40 per share. On November 1, 1999, the optionee chose to exercise the cash right of the tandem SAR for the first 100 option shares. The SAR FMV on the date of exercise was $12 per share. The calculation is:
| Calculation Step | Example |
|---|---|
|
Grant Price x Shares Exercised = SAR Cost |
3.40 x 100 shares = 340 |
|
SAR FMV x Shares Exercised = Exercise Value |
$12 x 100 shares = $1,200 |
|
Exercise Value − Cost of Shares = Ordinary Income |
$1,200 - $340 = $860 |
Withholding taxes are due on all SAR exercises. The funds paid to the optionee are treated as compensation and taxed accordingly for both ISO/SAR and NQ/SAR.
Taxes are calculated as follows:
| Calculation Step | Example |
|---|---|
|
Federal |
$860 x 28% = $240.80 |
|
State |
$860 x 6% = 51.60 |
|
Social Security |
$860 x 6.2% = 53.32 |
|
Medicare |
$860 x 1.45% = 12.47 |
|
SDI |
$860 x .5% = 4.30 |
|
Total Taxes Due |
$362.49 |
Recap of SAR Exercise Transaction:
| Transaction Description | Example |
|---|---|
|
Gain on SAR Exercise |
$860.00 |
|
Taxes Due |
$362.49 |
|
Total Due Optionee |
$497.51 |
|
Shares Exercised from SAR |
100 |