Executive Compensation: 7 Costly Mistakes to Avoid
As a busy executive, you might find it challenging to stay on top of the nuances surrounding your compensation package. There are often complex tax rules, regulations, deadlines and unforeseen factors. All of these can make smart financial planning difficult.
Here are seven common examples of costly errors you’ll want to avoid.
1) Not running tax projections before exercising incentive stock options (ISOs)
If you meet the holding period requirements, ISOs theoretically have no tax due when you exercise. Any gain that is taxed otherwise as ordinary rates when exercised can be taxed as a capital gain when you sell the stock. The spread on ISO shares held, however, can be subject to alternative minimum tax (AMT). It’s critical to run a tax projection before exercising and as early in the year as possible. If done early enough, there are ways to reverse AMT.
2) Not knowing how much your plan’s success depends on your stock-based compensation
A common mistake is relying too heavily on the performance of stock-based compensation to meet your goals. There are many factors you cannot control, and a lot can go wrong. Even if your company performs well, the market may not cooperate. It’s important to know how much a slowdown or decline in stock price may impact your goals. By diversifying away from concentrated holdings, you can better pinpoint the probability of achieving them.
3) Under-withholding tax
Often, companies will use the flat IRS rate when restricted stock units (RSUs) vest, which is currently 22% for amounts up to $1 million. This can be woefully low for executives who fall under this threshold, yet still sit in a higher tax bracket.1 To avoid penalties, run a projection to see what your expected tax bill is, and then decide if extra payments or withholding are necessary.
4) Letting in-the-money stock options expire
When options are granted, you generally have 10 years to exercise them before they expire. Do nothing, however, and they’ll expire worthless. Be aware that expiration periods can sometimes be much shorter than that (or reduced if you decide to leave the company), so pay attention to those dates. Never let in-the-money options expire. If you do, you’ll actually be throwing money away that you may never recover.
5) Putting tax considerations before the investment
Taxes are important but can be over-emphasized, especially with options where you have some control over when taxes are recognized. If the stock price plummets and your plan relies on these funds for success, you might have been better off paying the tax and ending up with more in net proceeds.
6) Not receiving deferred compensation payouts in a timely fashion
If you participate in a non-qualified deferred compensation plan and elected scheduled payouts, but find that you don’t receive them in a timely fashion, don’t ignore this delayed payout. The IRS is punitive in these situations. Follow up with your company to ensure payments are received as scheduled.
7) Missing the 83(b) election
Pay close attention if you receive restricted stock awards (RSAs), as you can opt for an 83(b) election. This allows you to pay tax now on the grant value today, versus when they vest later. Why do this? Ordinary tax rates apply when restricted stock vests. If you expect the price to go up, you can potentially pay less tax now. You also start the capital gain clock earlier on the held shares, which may be eligible for lower capital gain rates if held for at least a year. Since you must make the election with the IRS within 30 days of issuance, it’s important to analyze the pros and cons quickly. Risks are involved, so be sure to consult a professional, such as your Corient Wealth Advisor or tax consultant, before taking action. Also note that RSAs are different than RSUs. The latter is a promise to pay shares in the future and is not eligible for 83(b).
ABOUT THE AUTHOR
Gary Pattengale, CPA, CFP
Gary is a Wealth Advisor in our Itasca, IL, office. He specializes in executive and stock-based compensation plans, including stock options, restricted stock and deferred compensation. He combines his tax knowledge, executive compensation experience and capital markets expertise to help clients reduce their tax burdens and achieve each of their unique goals.
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