In the start-up frenzy of the dot-com era, many cash-challenged companies offered employees a piece of
the future in lieu of current payroll or cash bonuses. That piece of the virtual profit pie – a stock option –
had long been a method of compensation or bonuses for high-place executives.

Stock options may be one of the sole survivors of the dot-com crash. According to the National Center
for Employee Ownership, 10 million American employees now have stock options, compared to just 1
million in 1992. An estimated 20-25 percent of public companies offer options to the majority of their full-
time employees, and a few offer them to part-timers as well.

A stock option grants an employee the right to purchase a specific number of
shares in the company at a fixed price (also called the grant price) for a
specific number of years. If and when the share price increases, the employee
can exercise (or purchase) the stock at the lower fixed price, then sell it at the
current market price, realizing a gain.

Stock options may be nonqualified (meaning it does not receive special tax
treatment under the IRS code) or incentive (which do qualify for special
treatment). When you exercise nonqualified stock options and then sell them,
the gain is taxable as ordinary income. The issuer, which gets a tax deduction
for the same amount, can issue as many nonqualified stock options as it
wants to employees, officers, directors, consultants and vendors.

Incentive stock options can be issued only to employees and usually must be
exercised within three months of leaving the company. The grant value of
incentive stock options issued in a year cannot exceed $100,000. If you wait
two years to exercise the options and then hold the purchased stock for at
least one year, you receive favorable treatment for long-term capital gains tax
on all the appreciation over the exercise price. Exercise of incentive stock
options and sales of the stock may have alternative minimum tax implications.

Because realized gains from stock options and the valuation of unexercised
options that have had unrealized gains can be complex, you should seek the
help of a tax advisor, particularly regarding incentive stock options, which can
trigger the alternative minimum tax. Calculating tax impact also can provide
guidance on when to exercise options, as taxes may take a considerable cut
from your profits. Staggering exercises and sales over a period of time can
spread the tax burden over several years.

Your financial goals for proceeds from stock options, the amount of time
remaining to exercise them, your portfolio’s concentration in your employer’s
stock and tax issues all come into play in determining the best time to exercise options. A financial
advisor can help you calculate these factors to take some of the mystery and emotion out of exercising
stock options.

This article was submitted by Robert Valentine of Financial and Retirement Management.Robert Valentine is a well-known expert in the matters concerning investors. His articles on financial planning matters that concern investors have been published by several publications throughout the United States.