[00:00:00] Welcome to The Financial Call. We are financial advisors on a mission to guide you through the financial planning everyone should have, whether you're doing it yourself or working with a financial advisor. These episodes will help you break down complicated financial topics into practical, actionable steps. Our mission is to guide motivated people to become financially successful. Welcome to The Financial Call. This is episode five of season four, and this is all about taxes. This is an area where I feel like a lot of people have questions if it applies to them, and then the rest of the people could care less, and it's if you have a plan at work that offers you some sort of equity compensation, whether it's a plan that you put money into, I'm not talking about a 401k. I'm talking about buying stock in your company that you work for, or if they just give you shares or if they give you options. That's a company stock. If that's something that you have available to you at work, this 

[00:01:00] episode's going to be incredibly useful. And if you don't have that available to you, then you might just skip it. I don't know. There's really not a lot for you here today. Yeah, and it can get confusing cuz there are lots of different plans. But we're gonna go through each type and help explain the taxes so you can at least listen to what applies to you. So this is the fifth episode within the tax season. We've talked about how taxes are calculated. We've talked about Roth and traditional. Episode two three was how our non-retirement investments were taxed. Four is tax for strategies for retirees. and then now we're on episode five. This is for employee stock plans. And then the last episode in this season, Laura and I will sit down and just talk about some of the common tax myths that we run into. These are things that our clients here bring up to us and that oftentimes, I dunno if it's good marketing out there or whatever, but they just are fairly confusing tax myths that I think we can bust. Okay, so today is all about stock plans and the most common stock plan that people are familiar with, it seems like 

[00:02:00] is a stock option. Now, be careful. We're not talking about the type of options that you trade on the open market. That's a different type of option. This is the option to buy your own company's stock, and it's the right to buy it at a certain price. So some people might say, well wait a second. That's not that helpful to me to have the opportunity to buy something. You can buy the stock whenever you want cause it's a publicly traded stock, but it's the stock at a certain price. That's the benefit. So if you have the right to buy a stock at $5 a share and they lock that in, they call that your strike price, you're locked in. So you can buy it at $5 a share and then you can just wait for the stock to get, maybe it goes up to $15 a share and you get to pocket that $10 difference. That's called the bargain element, if you ever, I don't, I don't know if I've seen that. I saw that in the test books, but I didn't see it in real life when I was talking to both Zacc. Oh, Zach Geertsen here. We should have talked about that. . Welcome Zacc. 

[00:03:00] Welcome Zach. Uh, thank you. Yeah, good to have you. We brought Zach in because he worked in a group at a previous employer that serviced clients who had stock plans, and so he has detail and the knowledge of how to work through these and experience with it. Both Zach and I worked at the same, in that same department, so we'll be able to have a good time talking about some of those days, but, and this is Zach with an H? That's right. So we have Zacc Call Z A C C. This is Zach Geertsen, z a c h. His parents spelled it right. I didn't know any better. Okay. So that that individual who works for the company could buy their stock at $5 a share and sell for 15 pocket the difference. So why would you be given a stock option? Usually it's because of your work performance or it's job related, or they want you to stick around. Usually they provide stock options to upper level management or directors, or they call it the C-suite. The CEO. The COO, you know, the 

[00:04:00] executives at the firm. It's really their attempt to say, Hey, stick around. Because usually you have to wait a little while before you can exercise that stock option. Its standard is three year cliff is what they call it. Laura: It's the golden handcuffs to hold on. And I also think it encourages the employees to work for the company because they own a piece of it. You know, this stock does well, then they will do well. So it's to incentivize the employees in those two ways. Zacc: And Zach, maybe I can go through and explain some of the main things that someone should watch out for, and then you could maybe tell us a little bit about your experience actually helping people with these and some of the problems that people ran into. But the main things to watch out for are the grant date. So this is the date that the company says, Hey, Laura, you've done a great job. You're an upper level employee here. We're going to give you a hundred shares. You can buy a hundred shares of $5 a share, and you can do that in three years. It will vest in three years. So that's the vesting 

[00:05:00] date. So the grant date is the date that they make it like an agreement with you on it. The vesting day is the day that you can actually exercise it, that I have access to it. You got it right. Another way sometimes they do it is they'll do 20% of those shares. So of the hundred shares, they might vest 20 of them every year for five years, so that's another common way. Those are the two main ways, a three year cliff or a five year gradual vest. And then the real kicker here is that that doesn't last forever. Oftentimes I see 10 years, so in three years you could exercise them, but if you don't exercise them 10 years after that, the whole thing just vanishes. Laura: You know what this reminds me of? I don't know if you guys remember these box tops. You'd collect the box tops on top of the cereal, and then you turn it into the school, and if you got a certain amount, then you could win a prize. So I'd been saving them for years so that I could have a high chance of. So I, I go to submit 'em, my box tops, turn 'em into the school, and I found out that most of them were expired 

[00:06:00] by that point. I was so devastated as a kid to see that that had an expiration date on there. So watch out for those expiration dates Zacc: for sure. And think about this too. That is a good example, the way that it, so those box tops are worth the same amount, right? No matter what. Yeah, the stock price is going all over the place in the meantime. So that stock price movement, up or down, could affect the price cause for example, it's worth $10 a share. In our previous example, Laura got a hundred shares. She can buy at five and sell at 15. If that stock goes down $1, it drops from 15 to 14. Her difference, the bargain element is now $9 instead of 10. So the stock didn't go down 10%, but your value went down 10%. Yeah. And so that value actually fluctuates more than the stock price because of the way that the option works. So the stock price movement matters, and then we're gonna talk about taxes here in a minute. But Zach, you and I both, I feel like Starbucks was a common request they gave, and I think it's 

[00:07:00] because Starbucks actually gave stock options to just about everybody at the company, right? Zach: They did, yeah, absolutely. So when I was in this group, I spoke with so many different baristas that would call in, and a lot of them didn't have the expertise of what a stock option was. So there were a lot of. Educating and understanding what it was. Most of the time it was just, how can I get my money out? Right? But it was a great chance just to review the basics of what a stock option is. One other thing I just wanted to touch on here real quick is the way that the vesting dates work. There are specific laws that the government has in place where it cannot go over a 10 year timeframe. So in the example, let's say if there was a three year cliff, What would happen is you can't exercise anything within that first three years, and then there's like a seven year window in which they have to go ahead and exercise it. Oh, so some are even less. Some could even be probably seven years or five years, but the vast majority of 'em are 10. They cannot exceed that 10 year mark. Zacc: Got it. 

[00:08:00] When I was working with these types of plans, it was 2008, which was the great recession and everything was down. And so I would take calls from Starbucks employees that said, Hey, I'd like to sell my shares. Well, they had a right to buy at about $40 a share, and Starbucks was trading at about six at the time. So they, I would tell 'em, I tried to like ease into that conversation nice and soft because, It was a little bit devastating for them because they thought they had something of value, but they didn't because they could buy it at 40, and I would tell 'em, well, you don't wanna buy it at 40 and sell at six. You just lose money on the deal. And oftentimes they would come back to me and say, well, I don't actually wanna buy 'em, I just wanna sell them. And it's like, oh, dang it, you, you have to do both you, you can't. This is not something you actually own yet. It's a right to buy it and then sell it. And in many cases, they're cashless transactions, meaning, The example are that 

[00:09:00] we're talking about with you, you have a hundred shares and you have the right to buy at $5 and you know you if you know you're going to immediately sell them to the brokerage firm. So what normally happens is a company like Starbucks will hire a big firm, the Vanguards, Fidelitys, the eTrades of the world, and they'll have them manage it for them usually. And instead of you having to deposit $500 to buy your shares, to just get $1,500 back, The brokerage firm is just like, this is all gonna wash out and Laura's gonna have a thousand dollars left over. We are not gonna make Laura deposit cash. We'll just give her a thousand dollars out of the deal. So that's called an exercise and sale, and that's cashless for most people, and that's what they end up doing. Laura: I think it's helpful to compare it to a coupon. So you still do have to buy it, but you got the coupon, the option to buy it at a lower price. Zacc: Exactly. Okay. So there are two different types. Most people end up with what's called an NSO, A non-qualified stock option, and the difference, that

[00:10:00] bargain element that we talked about, the $10 in this case for Laura is subject to ordinary income. So they'll pay their regular income rates. Even shows up and you have to pay FICA tax on it and everything. So it's, it's taxed pretty heavily. It's just compensation. It's just like any other income that you get from work. The incentive stock options, they have a little bit better treatment if you can play by the right rules. So you might be able to get it at a capital gains rate, which is less than ordinary income, usually by about 10% less. But you have to hold it for at least a year. After you exercise for two years from the grant date, whichever is further out. So let's say that you've had this stock option. This stock option. Laura has for a hundred shares at $5 a share. She was given that from her employer five years ago. So we're way beyond two years from the grant date. And she decides she wants to exercise it. She needs to put, this is not a cashless transaction. She actually has to 

[00:11:00] put $500 in, buy the shares. And she needs to hold them for another year. I've used my coupon to buy. Exactly. And you've dropped that cash in the account and you've held it for a year. And let's say that that now goes up in value, cause immediately you put $500 in and it's worth immediately $1,500 cuz the stock is trading at $15. Let's say it goes up to $20 a share? Well, you have the bargain element, which is that thousand dollars. Immediate guaranteed just option that you got to buy in at a lower price, but you also have another $500 of growth on top of that. And if you do this right, you can be subject to long-term capital gains. So I'm just gonna leave it there without going into much more detail, but that's the bottom line on that. And I think that's it. Anything else to add to options, Zach, before we move on to grants? Zach: Yeah, just a couple things about the incentive stock option is that you do have to be an actual employee to receive those, or you can actually be like a 10 99 contractor to receive the NSO. Oh, interesting. Yeah, I didn't realize

[00:12:00] that. I used to always get questions when people had NSOs, should I exercise and hold them or should I exercise and sell them? It was very, very rare for anyone to exercise and hold to maintain those shares. It was always just a cashless type of transaction. When dealing with NSOs because there is not that tax. There's no tax incentive. In tax incentive. That's right. Yeah. Laura: So ISOs, you play the cards, right? You can get a better tax rate. The NSOs, you're always gonna have a higher tax rate. Zacc: Yeah. Now on the ISO though, you could lose money. Because you have to hold it for a year. So in the meantime, if the stock goes down in value, you'd lose way more than the tax difference. Laura: Yeah, that's interesting. And if you own a lot in there, maybe you're not as diversified as you should be. Right. And so that goes back to not letting the tax tail wag the dog. Zacc: You've got it. There are some crazy things like 3M, they have an option to do what's called a stock swap with those incentives, I hated processing those. They were so complicated. Those are the worst. They really were. But you could, 

[00:13:00] instead of dropping cash in, you could take existing shares that you had. and then trade them in for new shares. And you could keep the basis, it made it so you didn't have to sell your shares, which was nice to get the cash. But bottom line, that's the difference between incentive and non incentive and then exercise and sell and exercise and hold. Now a grant is different. We were wrapping up the option conversation where we talked about the option being a coupon to buy. The grant is just, they're just going to give you shares. You don't actually have to buy them. You probably don't have to do much. They're just going to drop into a brokerage account for you. And you won't have to do anything. You don't have to exercise. You just need to stick around at your job and wait for them to vest. Typically, when they vest, every company's a little different, so you'd wanna look up your plan. But most plans that I ran into, they just sell a certain number of the shares to cover the tax cost for you. And when I say to cover the tax cost, they're guessing they're not. It's just like your paycheck. They don't know 

[00:14:00] exactly how much taxes you pay. They're just making a guess. And it seemed like most of the companies did 25% federal tax withholding on that, so they'd sell a fourth of the shares. and then pay that money to the government for you, and then three fourths of the shares would stay intact and drop into your brokerage account. Now there may be state tax withholdings and other things like that, but you get the idea they're gonna withhold some and drop the rest into a brokerage account. So their simpler, restricted stock units versus restricted stock awards is not something we're gonna go into today, but those are the two names, RSU and RSA. You know that you're looking at a grant. Rather than the acronyms, NSO and ISO, those are options. So an option, you have to do something about it. A grant, you just need to stick around and receive it. Laura: And taxes on RSUs, you have to hold it for a year after the vest date to get that long-term capital gains rate. Zach: Yeah, it's just a normal share after that as if you 

[00:15:00] went out and bought it in the open market. Same rules apply there. I found out that it seems like RSUs and RSAs are becoming more and more popular with a lot of companies compared to the incentive or the non, or the NSO stock options. I don't know if it has something to do with just the ease of understanding what they are. And not worrying about the expiration as well. So I've just found out that it's a lot more frequent these days than it was 10 or 15 years ago. Zacc: Well, think about it. If those Starbucks employees had been given RSUs or RSAs, they would at least have something. It wouldn't have been much, but. If they got a hundred shares and they thought it was gonna be $45 a share, they thought they had a $4,500 bonus. Basically, that's sad because it would only be worth $600, but 600 is better than nothing. So then maybe, I mean, I can see the rationale there. It's very easy to be a little bit disenchanted with the stock options, but they're more lucrative if markets go up. Okay, so the next one is called an 

[00:16:00] ESPP. We've done options. We've done grants, and this is an employee stock purchase plan. I'll just tell you right now, if I had access to an employee stock purchase plan, I would participate right away without question especially, well, let me say this, if it had a discount, which I'll, I'll explain the discount, but most of them do have a discount, so we're gonna explain how this works, but I know I would participate in it even if all I did was buy it and sell it. So here's how the plan works. Kind of like a 401K plan. How they take money from your paycheck if you ask them to, and you can set aside a certain amount every paycheck, and instead of that going into some retirement plan, the cash just sits in a holding period. It's called the offering period. That's usually six months, but it can be different periods. That was the most common that I saw. Every six months, the company will buy stock with your cash, and we're talking about the company's stock. So you work for. 3M, they're gonna buy that 

[00:17:00] stock again. Now, we talked about Hyatt Hotels, so let's talk a little bit about an employee stock purchase plan with Hyatt Hotels. Most of the time, well, some of the time you have a really nice plan if you have what's called a look back. So they take the price at the beginning of a six month period, and then the price at the end of the six month period. Laura, when you and I were looking at this, we were messing around a little bit with Hyatt stock, and at the beginning of a six month period. It was $92 a share, and then at the end it was $111 a share. So that six month window, if you had set up or set aside cash in the holding period during the offering period, they would look at both of those numbers, $92 and $111, and they would say, which one's lower? Okay, back in August it was lower, so we'll give you that $92 option, plus we'll take another 15% off that and you get to buy, what is that, like around $10 less? 

[00:18:00] You, you're looking at like low eighties, $80 a share on 92, but it's actually currently trading at 111, so you're buying it at $80 a share and it's trading at 111. And you immediately have a really nice gain in there. That's if you have a look back now, if the stock goes down. They'll use the most recent price because that's lower than the older price six months ago. So the taxes on these get really messy. But before we move on, I just want to reiterate, you're setting your own money aside. The benefit that the company is offering you especially exists if they give you a discount and then it's kind of a little extra kicker, amplified if they let you do the look back and pick, and you don't have to actually pick. But if they pick automatically the lower of those two prices, Zach: In all companies too, they're gonna have their own set of rules where they can only set aside up to an X percentage, whether it be 10%, and then I know the IRS has a maximum deferral amount of $25,000 in a qualified 

[00:19:00] ESPP plan. And this is what we're talking about as a qualified ESPP, which there are some nuances with that, but just keep in mind that there are some limitations of how much you can put in there. Zacc: So we're not gonna model out all of the tax scenarios, but I want you to envision in your head a chart, okay? And then there's the price that you buy, which is discounted, right? The price of the stock that it was trading at when you purchased. So there's a difference there that could be considered income. Then there's the price when you finally sell it, and depending on how long you've held it. And which ones of those are higher or lower? This is one where I usually have to get a piece of paper out and draw it out for myself to just be able to see, okay, which of these are ordinary income? Which of these little segments are long-term capital gains and which ones are short-term capital gains? It could be all three in the same. Stock trade where different portions are taxed at different rates. Zach: And one of the quick things too is that most companies require that you keep these ESPP shares in the account in which you purchase them in, even if you don't sell the shares. But if you were to transfer them out or even gift them, that can mess up the taxes because a lot of that comes back on your normal tax withholding from the company. So that's why. We get some calls sometimes of people wanting to go ahead and gift or sell some shares within their ESPP, but they can't because the actual company is restricting it for this very reason to get all those data points appropriately sent to the IRS. Zacc: Yeah, they have to report it back on your pay stub if you sell these, because some of it could be ordinary income. That time period Zach is talking about is called the disqualifying dis. and it's two years from the grant or one year from the purchase, whichever is longer. Now we're using the six month example for the offering period. So that means that once you're done with the offering period, you've been six months into that two year window, so you have another 18 months left. So most people need to know it's 

[00:21:00] about a year and a half that you would need to hold those shares before. , you can either sell or give them away without having to pay a little bit more in tax. Now, this is where I go back to if I had a plan like this, even if I was just going to buy the shares and immediately sell them, I would, because in this case, we talked about buying at 80 and selling at 111. Who cares if you have to pay a little bit in taxes? , take the free money. Be careful to not let that sound too negative. Like, oh gosh, I don't wanna pay the taxes and I also don't wanna hold them for two years. I better just not participate. It's like, no, no, no, participate. Buy them, sell them. Pay a little in tax and you walk away with money. It's great. I think one of other things too is that you gotta take that into consideration of what other types of stock plan awards they have. If they have a bunch of RSAs or RSUs or stock options too. How does that fit into your overall financial plan? If they're starting to max out their E S P P, then all of a sudden they're gonna have all this exposure to one company that they can't get 

[00:22:00] away from. They're getting their paycheck from that company as well. So I would always say still it's just check with your advisor to make sure it's still within the realm of your financial plan where it makes sense or not. Yeah, that's a lot of concentration risk. Yeah. Your paycheck and your assets. Okay, so an employee stock ownership plan is a little bit more common with smaller businesses and more private businesses. This is a little bit different. This is where over time the company buys company stock for you or inside your retirement plan, they may offer that instead of, or in place of the matching or profit sharing inside a 401k plan. So I know a construction company locally that matches. And like a profit sharing gets dropped in as stock ownership shares of that private entity in their retirement plan. And then when they retire, they are bought out of those shares by the business and the stock price is valued every year. So they know how much wealth they have and they have 

[00:23:00] zero options in the meantime. They can't go in and say, I actually don't wanna invest in our company anymore. I'd like to buy things on the market. They don't have that choice. It's just you have to. The employee stock ownership plan, you also may get dividends from it, from profits of the business, and then oftentimes as they retire, they get purchased out. Now, it's not always a private company, but it seems to be more common that it's smaller and more private entities that do an employee stock ownership plan. Now, the reason you might do this is you want your employees to have a little bit more incentive. To Laura's point earlier you talked about employee stock options being an incentive. To help the employees be excited about pushing the stock price up. The employee stock ownership plan is the same concept. Imagine if half of your retirement plan was written on whether or not your business is successful financially, especially as you get older and approach retirement, you're gonna care a lot more. It's a little more incentive to work hard. Mm-hmm. So then the last example or 

[00:24:00] the last situation, it's not a plan, but it is a strategy to consider. This is called net unrealized appreciation. So for people who have an employee stock ownership plan, or people who end up with stock inside their 401k plan, there is an option. Now, most people, let's just maybe take a step back. Most people take their 401k and they either just withdraw from it as they need or want. I think most people end up actually rolling that to an IRA and then withdrawing from that and investing however they want. Now, there's one thing to consider. Before you do that rollover, it's called NUUA. And if you have, I know an example where someone had $500,000 of Zions bank stock in their 401k plan. It's the company stock. My wife worked there. This was not her account. I wish it was her account. She worked there for a much shorter period of time and they did all their matching in Zion's bank stock. When she made her 

[00:25:00] contributions, instead of just matching and letting her buy whatever she wants, they dropped it in Zion's Bank. Now she could sell that and buy something else, but she ended up with a lot of Zions bank stock relative to her account size because that's just what they did for her and kind of inertia. Just let it be that way. Right now, that person with a half a million dollars in Zion's Bank. If they only paid a hundred thousand dollars for it in the account and the rest was growth in the account, they could take that $500,000, move it out of the 401k. They would have to pay ordinary income rates on the 100,000, the portion that is what's called basis, the portion that they paid for it. They have to pay ordinary income rates that year. That's the bummer. But then the upside, the other $400,000 could be. Taxed at capital gain rates, long-term capital gain rates, that could be huge because that maybe is a 10% difference. And then let's give it another example. Like if that same person had paid

[00:26:00] $450,000 for it and there was only $50,000 of growth, NUUA would be awful because they would have to pay ordinary income tax on the full 450,000 that year, push them into way high tax brackets only to hopefully save maybe 10% on the 50,000. So maybe they saved $5,000 in taxes. They would eat that savings up way faster in paying ordinary income rates on the basis. So net unrealized appreciation is something you wanna look at individually. Look at your stock and your basis. It's something we can help you with, but if you can do it, it could save you. A lot in taxes. I've seen this with Zions Bank, which is a publicly traded company here locally in Utah. Flying J is big, like you got gas stations all over the place with Flying J. They are not a publicly traded company. They had an ESOP, but they do have an NUUA option as you retire. The problem with that, I ran into that with someone too. They had almost $2 million worth of flying J equity in their retirement plan. And the 

[00:27:00] basis on it was only two or $300,000 on paper, it sounded like a great idea to go ahead and do NUUA and move it over to a non-retirement account, pay the taxes on one or two, $300,000 in ordinary income, and then capital gains on the rest. But they don't allow a non-employee to continue to hold flying. So he would've had to sell all of his Flying J stock at retirement. So it would've been two, $300,000 of income and then 1.7 million of capital gains. And that was just too much. And we felt like over time, just moving the whole thing to an ira, if we're really careful, and if he doesn't spend too much, we can actually get it out at lower tax rates more gradually. So it depends on the situation, but that's N U. And that's all of the plans. Should we do a quick review and then call it a day? Let's do it. Sure. Okay. Employee stock options, things to think about. It's an option to buy, and then you can choose to sell immediately or sell later. and you get 

[00:28:00] to pocket the difference. They have vesting periods, they have expiration dates. You gotta be careful of that. Look out for those right grants. They're just giving you stock. They're going to withhold some taxes, most likely. Some companies let you deposit money to cover the taxes so you can get all the stock, but either way, you're gonna pay taxes on it. You don't have to do much. They're gonna drop into an account for you. Employee stock purchase plan. You're going to set money aside, kind of like a 401k, but it's not a four. You're going to have your monthly payroll deductions held for a period of time, and then every so often, usually six months, they're going to buy stock for you in the company stock, and you can choose what to do with it. After that, the discount helps, and sometimes a look back helps even more. Employee stock ownership plans, often it's part of a retirement plan and it's something the company helps either match or buy or just drop in as a profit sharing equity in the business and the net unrealized appreciation is a strategy you can use if you happen to own a decent amount 

[00:29:00] of your own company. Stock in a plan before you retire. You should be talking to somebody, hopefully some sort of financial advisor. We'd be happy to work through this with you to get a feel for whether or not N UA is worth it for you. We did it. Beautiful. Awesome. See you guys. See ya. This podcast is intended for informational purposes only and is not a substitute for personal advice from capita. This is not a recommendation. Or solicitation to buy or sell, any security past performance is not indicative or for future results, there can be no assurance that investment objectives will be achieved. Different types of investments involve varying degrees of risk, including the loss of money invested, therefore, It should not be 

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