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Your equity awards - now is the ideal time to plan for the coming tax year


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Let’s be honest, filing your annual tax return can be a hassle. While many people see this annual milestone as an opportunity to take a short break from minding their finances, it’s actually one of the best times to plan for the coming tax year.

Consider following these five steps now and you could find that next year’s tax return may come together with a little less effort. Please note that these steps are general in nature and relate primarily to U.S. federal tax matters, but do not consider your overall financial situation. In non-U.S. locations, tax implications will vary. This should not be considered tax advice and you should consult with your employer or tax advisor.


Alternative Minimum Tax (AMT) – Individuals with a higher income may be subject to the Alternative Minimum Tax (AMT). Under the tax law, certain tax benefits can significantly reduce a taxpayer’s regular tax amount. The AMT sets a limit on those benefits. If the tax benefits would reduce total tax below the AMT amount, the taxpayer must pay the higher AMT. Visit for more information on how to determine if you owe the AMT.

Nonqualified Stock Option (NQSO) – The right to purchase company stock at a specific grant price over a stated option term. Upon exercise, U.S. participants will recognize ordinary income (W-2 for employees, 1099-MISC. for independent contractors) equal to the difference between the fair market value on the date of exercise and the grant price. This income is subject to immediate tax withholding (for employees) at the point of exercise with any appreciation in value above the exercise price treated as a capital gain. In non-U.S. locations, tax implications may vary; consult your employer or tax advisor.

Incentive Stock Option (ISO) – The right to purchase company stock at a specific grant price over a stated option term. An ISO must also satisfy certain conditions under the tax code. You are typically not subject to taxation on the grant date or at the point of exercise (but see Step 4 - Assess the potential impact of ISO/AMT Actions below). Generally, an ISO entitles you to favorable tax treatment if the acquired shares are held for at least one year from the date of exercise and two years from the grant date (a “qualifying disposition”). If you adhere to the required holding period, the difference between the sale price and grant price will be taxed at a capital gains rate upon sale of the stock. However, if you sell off all or a portion of the shares before the expiration of the holding periods, you may recognize ordinary income and will be taxed accordingly (a “disqualifying disposition”). In non-U.S. locations, tax implications may vary; consult your employer or tax advisor.

Step 1) Review all your
grant terms

Review your equity award documents and statements for any changes to your award provisions and consider these questions:

  • When is the vesting of my options, stock appreciation rights, restricted stock/Restricted Stock Units (RSUs), and/or performance shares?
  • Will any stock options and/or stock appreciation rights expire this year?
  • Do I have nonqualified stock options (NQSOs) and/or incentive stock options (ISOs)?
  • Am I likely to get more stock grants? What types, and when?
  • What is the likelihood of reaching the goal(s) set for triggering the payout on performance share grants?
  • When would a sale of ISO shares not be a disqualifying disposition?
  • What happens if I am laid off or my company is acquired?

Step 2) Project your income and tax picture

  • Establish a baseline projection of what your income and taxes will look like this year and next – Assuming you don’t plan to exercise any outstanding options, it can be surprisingly helpful to just carry last year's numbers forward as an income and tax projection. Understand your cash needs for any special financial goals you have set for the near future and the long term. This two-year baseline becomes a crucial part of your stock option exercise strategy.
  • Forecast any financial and/or life changes – Consider potential salary increases, expense reductions, life events (such as marriage or birth of a child), restricted stock/RSU vesting or additional equity compensation in your tax projection. Compare the difference between Alternative Minimum Tax (AMT) and regular tax. This will be important if, for example, you plan to exercise and hold incentive stock options (ISOs) this year or next.

    What will your marginal
    tax rate be? If you anticipate your marginal rate will be lower this year than next year, you may want to exercise more options to take advantage of the
    lower rate.

  • Change your withholding strategy – Stock compensation may bump up the taxes that you owe, potentially making your current withholding insufficient to cover your tax liability. Consult your tax advisor regarding your income tax withholding amounts and any opportunities to adjust your withholding to plan appropriately.
  • Estimate your marginal tax rate – The effective marginal rate is the tax you pay on the next dollar of income. If you are anticipating higher earnings next year, your marginal rate this year may be lower than the marginal rate of your tax bracket next year and you may want to exercise options before year-end to take advantage of this.

Keep in mind: When you do your projections, you should consider if option exercises or restricted stock vesting will push your yearly income into a higher bracket and result in a jump in your income tax bracket, a higher tax rate for capital gains and dividends or the additional Medicare tax on compensation and the Medicare surtax on net investment income. See “Learn more”, below.

Step 3) Consider leveraging capital-loss carry-forwards

Do you have a capital-loss carry-forward from last year? A carry-forward is first used to offset capital gains in the current year, dollar for dollar up to the full amount of the carry-forward. Any remainder can generally offset up to $3,000 of income. In both cases, your regular tax bill could be reduced.

Capital-loss carry-forwards can reduce your tax bill.

For example, if you hold appreciated company stock from a NQSO exercise or restricted stock vesting, you will be taxed on any capital gains when you sell it. The capital-loss carry-forward from last year's unused losses can help to offset these gains, making it easier to diversify1 your investments away from overconcentration in your company's stock.

You may also be able to use a loss carry-forward strategy by making a qualifying disposition of ISO stock on which you have paid AMT. Keep in mind, that capital-loss carry-forwards also exist with AMT so when you have ISO shares, you need to keep two sets of records: one for ordinary income and one for AMT. The basis and gain or losses on a sale of stock are different under both tax methods. Any AMT credit depends on this difference. Even without AMT capital gains, $3,000 of AMT capital-loss carry-forward can generally be used to reduce your AMT income.

Step 4) Assess the potential impact of ISO/AMT actions

Although the exercise of an ISO does not result in current taxable income, exercising your ISOs could have AMT implications. For purposes of determining whether you are subject to the AMT, the difference between the grant price and the fair market value on the date of exercise is treated as AMT taxable income. You can avoid this AMT trigger if you make a disqualifying disposition during the same taxable year, but you will recognize ordinary income and lose your favorable ISO tax treatment.

You may not be aware that you can be subject to the AMT even in years in which you do not exercise ISOs. Sizable capital gains and/or high state and local taxes can be enough to trigger the AMT. General guidelines to help you better understand the AMT can be found at If you determine that you are likely to pay the AMT, you may need to adjust your tax strategy. A professional tax advisor can help you understand the impact of the AMT and recommend adjustments to your strategy

Step 5) Establish a plan

Setting exercise and sale targets now can help take emotion out of the decisions later in the year.

Now that you’ve explored some of the more strategic considerations related to your equity awards, you should consider establishing a more tactical plan for ongoing management of your awards.

Setting exercise and sale targets help take the emotion out of the decisions later in the year should your company's stock price spike up or down. Make sure to plan your exercises, sales, and swaps. You may also want to set near-term price or exercise date targets for options that are close to expiration. A time-based approach might mean exercising 1,000 options a quarter. This is similar to dollar cost averaging when you buy the same investment at regular intervals.2

When a limited time remains to exercise your options, be very mindful of selling windows and blackout dates. You do not want to leave a valuable option unexercised because of a blackout, or be subject to selling pressures during a stampede to exercise on the day when a window opens.

If you are an executive officer or director, you may want to consider setting up a Rule 10b5-1 trading plan to sell at the prices and times you prefer. To create these plans properly, you need to follow U.S securities laws and rules, and your Merrill Lynch financial advisor can help. You should also consult with a tax advisor and your legal counsel to determine whether a Rule 10b5-1 trading plan is appropriate for you. Look at your entire portfolio, including investments in your 401(k) plan, for the overall risk from all your holdings in company stock. In these days of volatile markets, be careful when a substantial percentage of your wealth is in your company stock, including options and/or restricted stock/RSUs.

Impact of recent tax laws on your equity compensation withholding taxes

Federal tax rates for the highest ordinary income bracket rose under the American Taxpayer Relief Act of 2012, which went into effect in January 2013. This affects the top flat withholding rate for supplemental wage income. In addition, people with high incomes face an increase in the Medicare tax rate, and for all taxpayers the Social Security rate on wages up to the yearly limit returned to 6.2% from the temporarily reduced rate of 4.2%.

The table below outlines the income levels that trigger changes in the withholding of federal and FICA taxes. (In addition, remember that withholding for state and local taxes may also be applicable to you.) The amounts withheld appear in the appropriate boxes of your Form W-2.

Income levels where withholding on equity compensation changed*

Income Level

Rate Change

Income over yearly Social Security wage cap ($117,000 in 2014)

Social Security tax rate drops to 0%.
Income under the wage cap is taxed at 6.2%,
up from 4.2% in 2012.

Supplemental income over $1 million during
a calendar year**

Required flat rate withholding at the top tax rate
of 39.6%, up from 35% in 2012.

Income over

Medicare tax rate increases by 0.9% to 2.35% on the
employee portion of the tax.

* No withholding applies to the exercise proceeds from ISOs.

** Note that different withholding rules apply to supplemental income of $1 million or less during a calendar year.

Learn more and take action

Visit the Equity Awards Education page for videos and Quick Tips on managing
your awards.

Merrill Lynch and its representatives do not provide tax, accounting or legal advice. Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state or local tax penalties. Please consult your own independent advisor as to any tax, accounting or legal statements made herein.

This content provides general information only. Neither the information nor any views expressed constitutes an offer or an invitation to make an offer, to buy or sell any securities or other investment or any options, futures or derivatives related to such securities or investments. It is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person who may receive this material. Investors should seek financial advice regarding the appropriateness of investing in any securities, other investment or investment strategies discussed in this content and should understand that statements regarding future prospects may not be realized. Investors should note that income from securities or other investments, if any, may fluctuate and that price or value of such securities and investments may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not necessarily a guide to future performance. Any information relating to the tax status of financial instruments discussed herein is not intended to provide tax advice or to be used by anyone to provide tax advice. Investors are urged to seek tax advice based on their particular circumstances from an independent tax professional.

This content is adapted from content provided under arrangement with, an independent source of online stock plan education and tools. Copyright © 2014. Inc. is not responsible for any errors in the article, or any actions taken in reliance on it. Please do not copy or excerpt the content without express permission from Inc.


1 Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss.

2 Keep in mind that dollar cost averaging cannot guarantee a profit or protect against a loss. Since such an investment plan involves continual investment in securities regardless of fluctuating price levels, you should consider your willingness to continue purchasing during periods of high or low price levels.