Gifting Stock Options to Family Members – What You Need to Know
Stock options have long been an attractive component of executive compensation. Sometimes we are asked if it is possible to transfer employee stock options to family members as part of an estate reduction strategy. It’s an interesting question and possible under certain circumstances. For executives that know they have enough to meet other goals and face a potentially taxable estate, it can be an effective strategy.
Why Consider Employee Stock Options?
Stock options have potentially much greater upside due to leverage. This means the value of the option can increase at a greater percentage than the stock itself.
With talk of lowering the federal exemption amount (i.e., the amount that can be passed gift or estate tax-free) from $11.7 million to as low as $3.5 million, this strategy can shift an asset with high appreciation potential out of your estate.
Whether a change in law happens is anyone’s guess. But don’t forget state death taxes, where the exemption levels may be lower. For example, in Illinois, the exemption amount is only $4m per individual.
When can you do this?
The plan must allow it, and the scope can vary. Full transferability in plans is rare, but some allow for limited transfers, which may include family members, limited partnerships, trusts for family members, or family-owned entities. If the plan allows and it does not violate the executive’s stock holding requirements or internal management views, then it’s possible.
- Options must be vested to be a completed gift. Valuation is key, so gifting vested options may be best. This way, the gift tax impact can be determined at the time of transfer, versus wondering what it may be later when they vest.
- You, not the recipient, will owe the tax due upon exercise. Therefore, it’s important to realize this is not an income tax reduction strategy. However, paying the tax is not considered an additional gift, so it essentially allows you to make a larger gift without using more exemption or additional gift tax.
- Your family member, not you, determines when to exercise. That said, it’s important to have arrangements in place to cover the income tax due at exercise.
- It may make sense to transfer options when the stock price is temporarily depressed. By transferring options where the spread is minimal or underwater, you can minimize the amount of exemption used or gift tax paid when making the gift.
- This strategy is not without risks. The option could expire worthless if the stock price falls below the grant price. You cannot recover the exemption used or gift taxes paid to make the transfer, nor any of the legal costs.
- Incentive stock options cannot be transferred. ISOs generally cannot be transferred during your lifetime and retain their preferential ISO tax treatment.
- There may be disclosure requirements. Be sure to coordinate any strategies you’re considering with your employer.
What about gifting stock options to charity?
You generally cannot do this with Incentive Stock Options, but non-qualified options may be possible. However, you are responsible for the tax bill when the charity exercises them. It’s better to gift appreciated stock instead, or exercise the option yourself and gift the cash proceeds to charity.
If you are not sure if your estate is taxable or not, or if any of the above can make sense for you, have an advisor run the numbers. It’s important to balance your goals between retirement and legacy and have enough for both. And don’t forget the dream scenario. All three are essential components to living a full life.
Gary K. Pattengale, CPA, CFP® is a Wealth Manager at BDF and is a member of the Firm’s Investment Committee. With 20-plus years of professional experience, Gary began his career as a public accountant, training that he uses to help his clients minimize their tax burden. He draws on his extensive experience to provide his clients with strategic insight into the planning and investment strategies most suitable to their circumstances. Gary earned a BS in Accounting from Northern Illinois University as well as the Certified Financial Planner™ and Certified Public Accountant designations. He is recognized as a FIVE STAR Wealth Manager by Chicago magazine, and is a member of the American Institute of CPAs and Financial Planning Association.
No representation is being made that any strategy shown will or is likely to achieve results similar to those shown in this presentation. BDF does not provide legal, tax, insurance, social security, or accounting advice. Clients of BDF should obtain their own independent tax, insurance, and legal advice based on their particular circumstances. The information herein is provided solely to educate on a variety of topics, including wealth planning, tax considerations, insurance, estate, gift, and philanthropic planning.