Challenge of success: advising corporate executives about stock options.

• Author: Goodfriend, Karen
• Position: EXECUTIVE COMPENSATION

As accounting rules change and investigations of backdating continue, stock options as a form of compensation have become more complex--and less popular. Still, stock options remain a significant form of compensation for many executives, especially in California.

[ILLUSTRATION OMITTED]

Many companies, in the start-up phase and well-established, grant new options. Additionally, executives who years ago received option grants often hold unexercised options or shares of their company stock obtained from previous exercises.

The development of a strategy for stock options goes beyond tax advising. Ideally, the process starts with the adviser gaining an understanding of the executive's financial goals and capacity for risk. Moreover, the level of investment diversification and investor psychology play a role.

To add to the complexity, executives are faced with legal and corporate restrictions on how and when their stock may be sold--restrictions which go beyond the scope of this article, but must be considered.

Further still, while tax implications are a major concern and executives may be tempted to adopt tax-minimization strategies since they hold the possibility of building greater wealth. If they don't address these other factors at the outset, the evaluation of tax consequences would be done in a vacuum, and they may not recognize the inherent risk in tax-minimization strategies to magnify losses if the stock price declines.

COMPENSATION PLAN

If you're working with executive clients with substantial options, it's important to start with a clear understanding of their overall compensation: salary, bonus, deferred compensation plan and other forms of stock compensation besides options (e.g., restricted stock grants). These other forms of compensation will be relevant when evaluating the executives' potential net worth, tax planning and overall concentration of their personal wealth in the company stock.

UNDERSTANDING STOCK OPTION GRANTS AND RESTRICTIONS

Regarding the executives' stock options, the adviser should understand the details of the company plan, option agreement and specific grants--including when options can be exercised or expire under a variety of circumstances, such as death, disability and termination of employment. The type of option--Non-statutory Option or Incentive Stock Option--will determine potential tax planning.

Generally, ISOs have the potential for more favorable tax treatment. If holding periods are met, ISO shares...