Companies are getting more and more competitive (and creative) with their compensation packages to find, attract, and keep skilled professionals. And with that creativity of new forms of compensation, SARs, or stock appreciation rights, are starting to gain steam. How stock appreciation rights work is interesting: sort of like a morphing of nonqualified stock options (NSO) and restricted stock units (RSU).
They’re fascinating, for sure, but if you’ve been given or accepted a job offer including SARs, you’ll need to grasp the tax implications of exercising them before you take action on them.
How do stock appreciation rights work?
First, let’s review how SARs work.
Think of RSUs: with an RSU grant, you automatically receive the underlying value of the company shares as soon as they vest into your possession, and you then deal with the further gain or loss of the shares once you sell them.
With SARs, though, you don’t automatically vest shares.
Instead, you “vest” the increase in the shares over time… and SARs don’t give you dividends or voting rights like owning shares in a company may.
If the stock price at the time your SARs are granted is $10, and you exercise when the stock price is $25, you receive $15 per share… the amount the stock has “appreciated,” in other words. You’ll have the option to play out this increase in cash, or in further company shares.
When it comes to taxes, the gains you earn on SARs are subject to ordinary income, social security, and medicare tax on the spread.
Why do job seekers like SARs?
There’s a reason stock appreciation rights are becoming so popular: employees love this option.
There is no cost to exercise (aside from taxes owed after the fact, and taxes are only triggered at exercise), and unlike RSU, you control when you exercise… meaning you can wait for a lower income year, or when the market is showing extraordinary gains.
‘Supplemental Wages’ of SARs + Taxes
One of the downsides of stock appreciation rights is that the federal and state governments consider their payouts to be supplemental wages, which means there is a fixed federal withholding rate (22% if your income is under $1 million), and fixed state rates.
This isn’t a huge issue, of course, especially if you plan for it, but it does create extra work to avoid an underpayment penalty because you had a shortfall in your total withholdings.
What if I’m leaving a job that gave me stock appreciation rights?
Just because SARs are gaining popularity today doesn’t mean they were totally unheard of in the past.
If you’ve got SARs in your current position, but you’re looking to move on to your next opportunity, study your company documents carefully. They will specify what your payout options are: cash or stock. Failing to read these carefully and executing your SAR plan based on even a small oversight could cause fairly large tax ramifications, and we’d hate to see that happen.
If you need help looking through and understanding your SARs documentation (and making a solid plan as a result), book some time with one of our financial planners.
Selling SARs When You’re Given Shares Instead of Cash
Since SARs are taxable upon exercise, what happens if your company gives you stocks instead of cash?
As expected, it makes things slightly more complicated.
Similar to RSUs, the gain you get upon vesting is added to your W-2 and counted as ordinary income, increasing your owed taxes.
Also similar to RSUs, you can sell some shares to cover your taxes, and any options sold in this batch will be subject to the short-term capital gains tax rate (ordinary income tax rate). Fortunately, if you sell immediately after exercising, your short-term capital gains should be minimal.
If you can, though, it’s great to hold your shares from SARs exercise for at least a year, because that qualifies you for the long-term capital gains tax rate, which is noticeably lower than the short-term capital gains tax rate. (It’s a 15% to 20% difference for most taxpayers.) Your basis in these long-term sales is the amount of “income” you received when you exercised your SARs.
Should I Sell or Hold My SARs Stocks?
Deciding to sell immediately or hold and sell is ultimately a decision for you and your financial planner. You have to consider many factors such as when to exercise, when to hold, determining your break even price for selling, and portfolio diversification.
Our team of experts can help you weigh the wealth-building and tax ramifications of these soon-to-be-favorite option grants of employers. Book a call with us here.
