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Author: mathetes Big red star, 1000 posts Old School Fool Motley Fool One Everlasting Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121180  
Subject: Re: tax advantage, NonQual Stock options Date: 4/16/2001 10:24 PM
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JesseSmit: Other than possible increases in stock price, is there a benefit to holding on to exercised non-qualified stock options? I recently read in a newspaper article that "long term holds"(i.e. over a year) only benefit incentive stock option exercisers since they will be probably taxed at the capital gains rate.

There are two periods for "holding" to consider. The first is the period of time between the grant date itself and when you exercise; the second is any holding from the time of exercise to the time of sale. I presume you're asking about the latter, but it's important to consider both.

The reason to hold on to the option as option -- wait till a time close to expiration -- is that most stock tends to increase in value with time. That's true, of course, whether NQ or ISO. But especially for NQs that you are planning to just turn over (buy-sell in one day), you might as well maximize the income potential.

As you know, exercising NQ options does expose you immediately to income tax, at your regular income tax rate, on the "bargain element" at the day of exercise. The difference between the option price and the FMV (Fair Market Value) is taxed. You also, immediately, can consider that FMV as your basis for whatever period (1 minute to 1 decade or more) you decide to hold on to the shares so acquired.

ISOs don't expose you to immediate regular income tax on the bargain element -- which is probably what you are referring to. That bargain element is liable to Alternative Minimum Tax, however. As many people have learned to their utter dismay in the last 12 months, if they hold on to ISOs waiting for Long Term Capital Gains rates taxes a year later, they may end up owing AMT in larger amounts than the stock is worth (if the stock falls precipitously in the same 12 months). That's hardly an advantage. ISOs held over a year (and over two years from date of grant) are taxed (not probably) at the long term capital gains rate. But because of AMT, it's a lot more complicated than that. You can end up, in effect, paying a good deal of that in advance and hoping that the stock stays up in value so you can reclaim the AMT credit.

So one additional benefit to NQs is simply that the tax is over and done with; but of course, if that stock then falls precipitously, you end up holding an investment that has declined in value.

The bottom line -- my apologies for such a lengthy reply -- the bottom line is that you need to educate yourself on all the nuances of each, and then be well versed in the riskiness of the company in question, and plan accordingly.

mathetes
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