Companies award their employees with stock options as an incentive. If you have an ownership stake in a company, you are more likely to put forth your best efforts, considering that you have a stake in the business success as well. One popular way of benefiting from stock options is by the cashless exercise of the options. Cashless exercise offers benefits to employees, but companies may not prefer this method.
When it comes time to exercise your stock options, you will generally have to pay the exercise price of the stock option to buy the shares. One way of avoiding this cash outlay is to do a cashless exercise of stock options. Some companies have set up programs with stock brokers to allow you to do a cashless exercise, whereby the broker loans you the money to exercise the stock option and buy the stocks. Then you could immediately sell the stock and generate enough money to pay back the money borrowed from the broker to exercise the option, as well as commissions and taxes. You keep the balance of the cash.
Most companies issue nonqualified stock options, which do not generate any favorable tax treatment when you exercise your option to buy the underlying stock. When you exercise the stock option, you will have to report the exercise as ordinary compensation income. Your employer is compensating you with stock. And on selling the stock, you will have to report capital gains or losses. A cashless stock option exercise will result in a short-term gain or loss.
Companies in general may not favor cashless exercise of stock options. When you exercise the option and sell the stock on the same day, you may not really have any interest in the larger goals of the company, which defeats the purpose of conferring the stock ownership. Some companies have longer vesting periods to deal with this issue. This means that you will have to wait longer to exercise your stock options.
- Penn State University: Cashless Exercise: Why Few People Keep Shares
- Fairmark.com: Cashless Exercise of Nonqualified Options
- National Center for Employee Ownership. "Stock Options, Restricted Stock, Phantom Stock, Stock Appreciation Rights (SARs), and Employee Stock Purchase Plans (ESPPs)." Accessed Oct. 20, 2020.
- Charles Schwab. "Your Stock Award." Accessed Oct. 20, 2020.
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- IRS. "Topic No. 427 Stock Options." Accessed Oct. 20, 2020.
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- IRS. "Topic No. 409 Capital Gains and Losses." Accessed Oct. 20, 2020.