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Retired Military Finances 401: Non-Qualified Stock Options

Investment Retirement Funding Taxes

When you retire from the military you'll realize that, unlike your military compensation, there are a lot of variations in civilian compensation. This is especially true when it comes to non-qualified retirement plan. Non-qualified retirement plans are normally offered to employees that are really important to the company. This could be the case for executives or employees with critical skills. One type of non-qualified plan is Non-Qualified Stock Options (sometimes called Non-Statutory Stock Options).  Tax ramifications with non-qualified stock options are not simple and  the tax treatment is different depending on whether the options have a a readily ascertainable fair market value.  Most non-statutory options do not have a readily ascertainable fair market value. We'll cover that type in this article.

At it's roots a non-statutory stock option plan (I'll call it just the "Plan" going forward), grants stock options (the right to buy company stock at a set price) to employees or contractors of the company. The options can be exercised (buy the stock) after a certain amount of time passes. If the exercise price is lower than the fair market value of the stock, you get to buy the stock at a discount.

When you receive the option (it's grant), since there is no readily ascertainable market value there are no tax ramifications.  The basis (used when calculating gains or losses) on the option, is what you pay for it (likely nothing).

When you exercise the option and the stock becomes fully vested (could be different dates) you must include the difference between the fair market value of the stock and the the price you paid for the stock when exercising the option (the "spread") as income on your tax return.  Note that you have no income/earnings from this transaction, but there is a tax bill due.

Your holding period on the stock starts on the day after the day you exercise the option. You'll need to wait one year to get long-term capital gains tax treatment.

When you sell the stock, your gain is equal to the price received for the stock minus the sum of 

  • The amount you paid to exercise the options
  • The amount you included in income upon exercise of the option (the spread)
  • The basis in the options (if one exists)

What if you never buy the stock or sell the option? Sometimes stocks go down in value (you probably already knew that).  If the fair market value of the stock is less than the price you can buy it with using the option, the option isn't worth much.  If the option expires, you can deduct the basis, if you have any, as a loss.

Non-statutory stock options are pretty complicated and there are reporting requirements not covered here. If the boss starts talking about these, give us a call...

If you found this article useful, you might like the following blog posts:

6 Mistakes Retired Military Officers Can Make that Could Mess-Up Their Ultimate Retirement


You've Made it When...


Don't Leave Money on The Table (And Don't Get Double Taxed Either)




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