Can Stock Options Be Transferred?

Employee stock option is a key remuneration for C-Class executives.

Options are taxable as they are part of a person's asset. Can options be transferred? Incentive Stock Options are subject to a general prohibition against transfer, although ISOs may be transferred to an employee's beneficiaries (including the employee's estate) upon the employee's death.

When you die, your properties are considered as an estate on which taxes may be owed. 

Transferring Assets

Transfer of assets is one of the pillars of estate planning. Some assets appreciate the value and get out of your control before you die. An example of such assets is stock options. These assets are not part of the taxable state, but tax is still a factor. When you make a transfer, gift tax rules apply, and when your transferees exercise the options, other taxes are owed. If the company's stock price is greatly appreciated, then the value of gift taxes will be much lower than the estate taxes.

Assume when the transferees exercise the option and share price value is doubled. After taking the tax liability into account, the asset's cost becomes four times the value they would have received if the transfer was not made. Now, IRS has made transferring complex. However, when decisions to options transfer are made, it raises some other answerable questions as well. 

How Transferable Stock Options Work? 

Options can be transferred if your company’s stock plans allow you to do so. Transferable stock options are non-qualified stock options (NQSOs) that you can transfer to only permit entities or individuals. Now the question is what are permitted entities? Permitted transferees include family members, limited partnerships, trusts for family members, or other entities owned by family members. 

The simplest transfer is a vested option to a child, grandchild, or another heir when you transfer options to a family member. The transfer of a vested option to any of the mentioned transferees is considered as a complete gift for gift tax purposes. In 2020, you can gift up to $15000, and married couples can gift up to $30,000 to each donee. When the gift limit exceeds this annual limit, it goes against lifetime gift tax exclusion. In 2020, there is an exemption of $11.58 million for unmarried taxpayers and $23.16 million for married taxpayers. Make sure that the transfer of options doesn’t exceed this lifetime limit. Otherwise, you will have to pay gift taxes at the end of the transfer. 

Now, the owner of the option is a family member transferee and decides when to exercise the option. However, the end of your employment means a decrease in the option term regardless of the option is held of the transferee. When a transferee who is a family member exercises the option, they pay income tax on the spread between exercised price and market price. If you don’t need cash, then tax payment reduces your estate further. Any fortunate family member transferee then receives shares that are free from taxes. There will be no further gift taxes on the options. At the time of exercise, stock price equals the tax basis. 

Trusts, Family Limited Partnerships, And Charities as Transferees 

Now, the situation is different, and many executives prefer to transfer their options to trusts instead of direct to family members. Moreover, they transfer options to family-limited partnerships, receive interests, and then gift this interest to family members. Both family limited partnerships and trusts allow you to structure tax gifts more closely to the one you desire. Moreover, these vehicles can provide relaxation in gift tax payable. 

The third option is to transfer to charities. However, it’s not wise to transfer stock options to charities. Such conditions are put on the options so that it will not be considered as a complete gift until the option is exercised. In this way, payable income tax can be nullified with the option of your exercise. 

Moreover, SEC doesn’t permit the stock options to be exercised by charities and transferred options to be registered under employee benefit plans. For doing this, you need to have a more extensive registration form. Therefore, your company wouldn’t allow you to transfer options to charities. 

Tax, Securities and Other Issues

Generally, tax, accounting, and securities issues are resolved for transferring vested NQSOs to family members, family-limited partnerships, and trusts for family members. Now, SEC has changed the forms to allow public companies to register the stock received upon exercise of transferable options to trust for family members, family members, and family limited partnerships. Moreover, SEC has changed the rules for private company stock plans. 

The IRS is less cooperative about making a complete gift of non-vested options. The main concern for IRS was that the executives were transferring assets immediately after the grant when they see a little increase in value. It forced the IRS to change the rules on how options must be vested for the transfer to be a complete gift. All the experts are not agreed with this ruling because gift-tax purposes can’t be determined until the options vest. 

Executive wait to transfer options until they are vested and when they have more surety of the value for gift-tax purposes. Models are used to value options, and it’s not a mechanical process. ISO options are non-transferable, but it doesn’t mean that they can’t be transferred. They can be transferred when they are converted into NQSOs, and lose the tax benefits of ISO. 

Decisions and Steps to Transfer Stock Options

When you decide to transfer options for estate-planning purposes, follow the below-given steps and decisions. 

• Make sure that your stock options are transferable. 
• Identify the appropriate transferee for options transfer. 
• Determine the benefits of family limited partnerships and trusts. 
• Share your numbers with financial advisors. 
• Identify the value of options for gift-tax purposes. 
• Understand the financial downside. 
• Transfer vested options at first priority. 
• When you plan to exercise the option, consider the income tax liability. 
• Consider the perceptions associated with transfers. 
• Don’t forget the rules for senior executives and directors. 

Can stock options be transferred? Yes, stock options can be transferred, but you need to identify the transferee and tax-gift purposes.