Job Events: Termination.
The Internal Revenue Code is very clear on the requirements of favorable tax treatment for ISOs. Among other conditions, you must be an employee of the company from the time of grant until three months before exercise. If your company allows you to exercise your ISOs after 90 days (at many companies vested, unexercised options expire 90 days after termination), the ISOs become NQSOs and are taxed as NQSOs at exercise (see a related FAQ). In some situations the three-month mark occurs on the 91st or 92nd day, so you may retain ISO treatment at exercise even after the 90-day point.
Alert: The three-month mark can be more favorable, so note any difference in length from the 90-day period. Switching into the role of a consultant or an advisor after your termination is not likely to be considered a continuation of employment that lets your grants remain ISOs after three months. See the case of Humphrey (US Tax Court, 2006-242).

Do Stock Options Terminate With Employment?
ESOs can allow employees to buy company stock at below-market rates.
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Employers sometimes use employee stock options, or ESOs, as a financial incentive for employees. ESOs give employees the option to buy company stock at a future date at a price established when the option is granted. Employees do not pay for their stock until they exercise their options. ESOs do expire, and employees who leave the company typically have only a short time to exercise their stock options.
Statutory and Non-statutory Options.
The Internal Revenue Service classifies ESOs as either statutory or non-statutory. If the employee can immediately exercise an option in full or transfer the option, it is likely a non-statutory option. The IRS has no provisions requiring expiration dates for non-statutory options. The rules are different for statutory option plans. Depending on the plan, employees have up to 90 days after their employment ends to exercise the option unless they become disabled, in which case the IRS extends the deadline to one year. However, the company's plan can reduce the time to exercise options after termination.
Most statutory ESOs require employees to be vested before they can exercise the options. Vesting simply means that employees must work for the company for a certain period of time to earn the right to exercise their stock options. Most plans divide the total number of options over a period of several years and grant purchase rights on a percentage basis. For example, an employee receives the option to buy 1,000 shares of stock. Assuming the vesting rate is 25 percent per year, the employee can buy 250 shares after working for the company for one year. If he does not exercise his option, after two years, he can buy 500 shares, 750 shares after three years or 1,000 shares after four years. When an employee leaves the company, his exercise rights are typically limited to the amount he has vested.
Stock Option Plans and Options Agreements.
Companies must prepare two documents related to employee stock options. The first is the stock options plan, which is approved by the company's board of directors and provides information of the rights of the employees covered by the plan. The second is the options agreement, which is normally prepared on an individual basis. This document spells out the price per share the employee must pay, how many shares the company is granting and how the employee will become vested in the plan. Either of these documents should contain the details on exercising options if employment terminates. The plan can require terminated employees to exercise their stock options within 24 hours of termination, for example, or grant them 30 days. Plans and agreements can also contain provisions that do not allow certain employees to exercise their ESOs, such as employees leaving the company to go to work for a competitor. Employees dismissed for cause, such as embezzlement or excessive unauthorized absences, may also forfeit their options under a plan's provisions.
Blackout Dates.
The company's ESO agreement or plan may contain certain dates that employees cannot exercise options or sell stock purchased through options. For example, the plan may require employees to hold their shares for a fixed time before selling them or forbid sales during the final month of the company's fiscal year. Terminated employees should pay careful attention to any blackout dates listed in their company plans or agreements to avoid losing their options. For example, if an employee is terminated on November 20 and the plan provides 30 days to exercise options but forbids employees to exercise options during the month of December, the terminated employee actually has only 10 days to exercise his options.
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About the Author.
Jeffrey Joyner has had numerous articles published on the Internet covering a wide range of topics. He studied electrical engineering after a tour of duty in the military, then became a freelance computer programmer for several years before settling on a career as a writer.
Photo Credits.
Jupiterimages/Photos/Getty Images.
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Six employee stock plan mistakes to avoid.
Understanding tax implications and your plan’s rules are among the keys to success.
Stock Plans.
Financial Planning Stock Plans.
Financial Planning Stock Plans.
Financial Planning Stock Plans.
Financial Planning Stock Plans.
Financial Planning Stock Plans.
Stock options and employee stock purchase programs can be good opportunities to help build potential financial wealth. When managed properly, these benefits can help pay for future college expenses, retirement, or even a vacation home.
But many investors get tripped up, don’t pay attention to critical dates, and haphazardly manage their employee stock option grants. Ultimately, they lose out on the many benefits these stock option plans can potentially provide.
To help ensure that you maximize your stock option benefits, avoid making these six common mistakes:
Mistake #1: Allowing in-the-money stock options to expire.
A stock option grant provides an opportunity to buy a predetermined number of shares of your employer’s company stock at a pre-established price, known as the exercise or strike price. Typically, there is a vesting period ranging from one to four years, and you may have up to 10 years in which to exercise your options to buy the stock.
A stock option is considered “in the money” when it is trading above the original strike price. Say, hypothetically, you have the option to buy 1,000 shares of your employer’s stock at $25 a share. If the stock is currently trading at $50 a share, your options would be $25 a share in the money. If you exercised them and immediately sold the shares at $50, you’d enjoy a pretax profit of $25,000.
You may be tempted to delay exercise as long as possible in the hope that the company’s stock price continues to go up. Delaying will allow you to postpone any tax impact of the exchange, and could increase the gains you realize if you exercise and then sell the shares. But stock option grants are a use-it-or-lose it proposition, which means you must exercise your options before the end of the expiration period. If you don’t act in time, you forfeit your opportunity to exercise the option and buy the stock at the strike price. When this happens, you could end up leaving money on the table, with no recourse.
In some cases, in-the-money options expire worthless because employees simply forget about the deadline. In other cases, employees may plan to exercise on the last possible day, but may get distracted and therefore fail to take necessary action.
“Ask yourself how much extra value you may get by waiting until the last second to exercise your award, and determine if that’s worth the risk of letting the award expire worthless,” says Carl Stegman, senior vice president, Fidelity Stock Plan Services.
Consider these factors when choosing the right time to exercise your stock options:
What are your expectations for the stock price and the stock market in general? If you think the stock has peaked or is likely to fall in the future, consider exercising and selling. If you think it may continue to go up, you may want to exercise and hold the stock, or delay exercising your options. How much time remains until the stock option expires? If you are within 60 days of expiration, it may be time to act, to avoid the risk of letting the options expire worthless. Will you be in the same tax bracket, or a higher or lower one, when you are ready to exercise your options? Taxes have the potential to eat into your returns, so you may want to exercise and sell when you are in the lowest tax bracket possible—though this is just one factor to weigh in your decision.
Tip: Monitor your vesting schedule, keep your contact information updated, and respond to any reminders you receive from your employer or stock plan administrator.
Mistake #2: Failing to understand the tax consequences of ISOs.
There are two kinds of stock option grants: incentive stock options (ISOs) and nonqualified stock options (NSOs). When you receive an ISO grant, there’s no immediate tax effect and you do not have to pay regular income taxes when you exercise your options, although the value of the discount your employer provided and the gain may be subject to alternative minimum tax. However, when you sell shares of the stock, you’ll be required to pay capital gains taxes, assuming you sold the shares at a price higher than your strike price. You must hold your shares at least one year from the date of the exercise and two years from the grant date to qualify for the long-term capital gains rate.
If you sell ISO shares before the required holding period, this is known as a disqualifying disposition. In such a case, the difference between the fair market value of the stock at exercise (the strike price) and the grant price—or the entire amount of gain on the sale, if less—will be taxed as ordinary income, and any remaining gain is taxed as a capital gain. For most people, their ordinary income tax rate is higher than the long-term capital gains tax rate.
While taxes are important, they should not be your sole consideration. You also need to consider the risk that your company’s stock price could decline from its current level. “Be aware of your tax situation, but also understand where you are in the marketplace, because there are also risks to continuing to hold the shares,” says Stegman. “Know which shares are qualified for special tax treatment, what the holding periods are, and transact accordingly.”
Tip: Consult with a tax advisor before you exercise options or sell company stock acquired through an equity compensation plan.
Mistake #3: Not knowing stock plan rules when you leave the company.
When you leave your employer, whether it’s due to a new job, a layoff, or retirement, it’s important not to leave your stock option grants behind. Under most companies’ stock plan rules, you will have no more than 90 days to exercise any existing stock option grants. While you may receive a severance package that lasts six months or more, do not confuse the terms of that package with the expiration date on your stock option grants.
If your company is acquired by a competitor or merges with another company, your vesting could be accelerated. In some cases, you might have the opportunity to immediately exercise your options. However, be sure to check the terms of the merger or acquisition before acting. Find out if the options you own in your current company’s stock will be converted to options to acquire shares in the new company.
Tip: Contact HR for details on your stock option grants before you leave your employer, or if your company merges with another company.
Mistake #4: Concentrating too much of your wealth in company stock.
Earning compensation in the form of company stock or options to buy company stock can be highly lucrative, especially when you work for a company whose stock price has been rising for a long time. At the same time, you should consider whether you have too much of your personal wealth tied to a single stock.
Why? There are two main reasons. From an investment perspective, having your investments highly concentrated in a single stock, rather than in a diversified portfolio, exposes you to excess volatility, based on that one company. Moreover, when that company is also your employer, your financial well-being is already highly concentrated in the fortunes of that company in the form of your job, your paycheck, and your benefits, and possibly even your retirement savings.
History, too, is littered with formerly high-flying companies that later became insolvent. When Enron filed for bankruptcy in 1999, more than $1 billion in employee retirement savings evaporated into thin air. More recently, Lehman Brothers employees shared a similar fate.
Consider, too, that income from your employer pays your nondiscretionary monthly bills and your health insurance. Should your company’s fortunes take a turn for the worse, you could find yourself out of a job, with no health insurance and a depleted nest egg.
“Stock from an equity plan is usually a large component of an employee’s annual compensation, so it’s easy to become overly concentrated in your employer’s stock,” says Stegman. “But you need to take a step back, consider how these benefits fit into your long-term financial objectives, such as college savings, retirement, or a vacation home, and develop a plan to diversify accordingly.”
Tip: Consult with a financial advisor to ensure that your investments are appropriately diversified.
Mistake #5: Ignoring your company’s employee stock purchase plan.
Employee Stock Purchase Plans (ESPPs) allow you to purchase your employer’s stock, usually at a discount from the stock’s current fair market value. These discounts typically range from 5% to 15%. Many plans also offer a “look-back option,” which allows you to buy the stock based on the price on the first or last day of the offering period, whichever is lower. If your company offers a 15% discount and the stock rose 5% during the period, you could buy the stock at a 20% discount, already a healthy pretax gain.
Unfortunately, some employees fail to take advantage of their company's ESPP. If you are not participating, you may want to give your ESPP a second look.
Entry-level employees often opt out of their ESPP, notes Stegman. “But as they become more established in their careers and more financially secure, they should reconsider their ESPP. Depending on the discount your company offers, you could be passing on the opportunity to buy your company's stock at a significant discount.”
Tip: Look at your current savings strategy—including emergency fund and retirement savings—and consider putting some of your savings in an ESPP. You may be able to use future raises to fund the plan without impacting your lifestyle.
Mistake #6: Failing to update your beneficiary information.
Few people like to think about it, but it’s important to keep your beneficiary designations up to date. As with your 401(k) plan or any IRAs you own, your beneficiary designation form allows you to determine who will receive your assets when you die—outside of your will. It’s important to note, however, that if the decedent has made no beneficiary designation, under most plan rules the executor (or administrator) will, in fact, treat equity compensation as an asset of the decedent's estate.
Each time you receive an equity award, your employer will ask you to fill out a beneficiary form. Many grants range in life from three to ten years, during which time many factors can change in your life. For example, if you were single when you received an option grant, you may have named a sibling as the beneficiary. But five years later, you may be married with kids, in which case you would likely want to change your beneficiaries to your spouse and/or children. The same holds true if you were married and got divorced, or divorced and remarried. It’s important to always update your beneficiaries.
Tip: Review your beneficiaries for your equity awards—as well as your retirement accounts—on an annual basis.
Learn more.
Understand the different types of employee compensation plans. Read Viewpoints: "Make the most of company stock."
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90 days to exercise stock options

Subject: quick question about stock options.
Hi there, I have a really quick question regarding stock options.
I was let go by my company and for some reason I thought I had 90 days to exercise my options after termination. It’s now been 50 days and I was just informed that I only had 30 days according to our stock option agreement (which no one has a copy of). So I’ve effectively lost my options, and we’re talking about a lot of options. 750,000, or 2.5% of the company to be exact. What legal recourse do I have to exercise them?
Any help is most appreciated.
Date: Wed, 16 Sep 2002.
I’m not an attorney, so I can’t answer your question. If you call me, I’ll refer you to an attorney who may be able to help.
I am printing your question to remind readers that the Internal Revenue Code provides the maximum guidelines for plan provisions, but the plan document can provide more restrictive requirements.
According to §422(a)(2), in order to qualify as an ISO, the taxpayer must have been an employee of the company granting the option or a parent or subsidiary of the company during the period beginning on the date the option was granted and ending on the date 3 months before the exercise date.
Some companies are more liberal and allow the employee to continue holding the options, which are converted to non-qualified stock options three months after termination. Some companies, like yours, have a shorter time frame for expiration.
The company should have provided a copy of the stock option plan to you when the option was granted. If you didn’t receive a copy or a summary of the plan provisions, you may have a basis for a claim.

Extending the Option Exercise Period — A Tactical Guide.
Stock options are, and will continue to remain, the primary way startup employees are rewarded for their time and effort. Thus, a debate has sprung up on whether the so-called “golden handcuffs,” the 90-day stock option exercise period, is fair. Several companies have now led the way in making a change, instituting option extension programs, extending the exercise period after you leave a company from 1 year to even 10 years. When Quora and Pinterest decided to change their policies, it was highlighted very publicly in tech news and blog posts. You can read Pinterest’s Medium post on their option extension program here. Others like Asana, Coinbase, Palantir, and Square have since followed suit. As the project manager in charge of the option extension at Square, I want to share some of my findings with a focus on how to implement it.
The arguments for and against making this type of change are better covered elsewhere, but I will note the PROs and CONs we considered at Square before deciding to extend the option exercise period, and discuss how it works from an accounting perspective. I will also share some findings we saw after the implementation, which may help you make the decision of whether or not to take this on at your own company.
The first step is to decide if an option exercise extension is right for your company:
Frees employees from tying up significant dollars in financial risk Allows employees to keep what they have earned — seems like the right thing to do Keeps employees here who want to be here — avoids the “vest and rest” problem Reduces the number of employees using unapproved investors and loan companies to acquire the funds to exercise Positive tool for recruiting — shows commitment to employees and differentiator from other startups Consistent with culture and mission of many startups.
The “elephant in the room” — may lead to increased attrition for those already looking to leave Tax withholding and reporting for former employees may require putting them back on payroll Foreign regulatory issues may be problematic (e. g. security law exemptions may only apply to US employees) — may not be able to offer this fairly across the whole company Administrative costs to modify agreements/plans and track modified awards Stock based compensation charge — will likely have a one-time charge for all vested options and an increase in stock comp expense over the remaining vesting terms of the awards.
Modify options for all employees, regardless of service Modify options only for those with > 1, 2 or 3 years of service Choose an alternate approach — eg. net exercise, partner with a lender, or tender offer.
After thorough evaluation of our alternatives, we decided the best decision for Square was to extend the exercise period for all employees who had been with the company for a minimum of 2 years. The best way to go about this for us was to modify all the awards at one time (this becomes important later when I describe modifying all at once versus on a rolling basis). Why did we pick 2 years? We felt that after 2 years an employee has made a significant impact at the company, and the 2 year requirement limits some of the attrition risk.
How do you account for this change?
NQs and ISOs.
Once you have decided you want to extend your option exercise period, you must first take an inventory of all your options to determine which are Nonqualified stock options (NQs) and which are Incentive stock options (ISOs). This is an important distinction, as ISOs must be converted and will lose their ISO tax status, because by definition ISOs can only have a 90 day exercise period after termination.
In Square’s case, we were lucky that the vast majority of our awards were already NQs, and we decided to not convert any ISOs except for on a one-off basis. If you have ISOs, you have to complete a 29 day conversion period to convert the ISOs into NQs (your lawyers can explain the 29 day conversion period and help you with this process).
Pick an Effective Date.
You then need to pick an effective date for the modification and notify all employees of the upcoming change to their exercise period. If all options are already NQs, then you simply need to send out a one-way communication of the change to all employees, since this is a favorable modification for them. ISOs are a little trickier, as you must have each employee sign a conversion document to convert the awards to NQs, and communicate the advantages and disadvantages of doing the conversion (primarily giving up the advantage of not having to pay taxes on the spread immediately upon exercise).
At Square we modified all options on the effective date, regardless of the service period, and modified all awards at once, even if the employee hadn’t hit their two year mark. Employees would still only qualify once they hit two years of service, but their option grant would already be considered modified. This does, however, add to your stock-based compensation charge, as you are modifying all your options at once.
Another option is to modify each individual award on a rolling basis once an employee hits 2 years of service, which is what I believe Pinterest ended up doing. However, I would suggest modifying ALL the options at once and not on a rolling basis, or it becomes a nightmare for stock comp tracking purposes (you will essentially end up calculating the incremental expense each month for each award that now qualifies).
Calculating the Stock-Based Compensation Impact.
As with most accounting decisions, you can either take the more aggressive or more conservative position, and this applies to calculating the stock comp impact of an option extension change. As this is changing a key term in the option agreement, it is considered a modification under stock-based comp accounting guidance.
The aggressive argument is that the change will have no impact on stock-based compensation expense. This is assuming you already use the “simplified method” to calculate the expected term of your options. If you are familiar with the Black-Scholes Model and use the simplified method, which can be used if you lack exercise history, then your expected term is probably 6.25 years, or 6.08 years for those “plain vanilla” options with 4 year vesting (1 year cliff, monthly thereafter) and 10 year expiration. Since 6 years is already a long exercise timeline, and likely higher than your actual exercise data would show, you could argue that this would not change your expected term, and therefore not change your stock comp expense. There is an argument that this change in exercise period would preclude the use of the simplified method, as the options can no longer be considered “plain vanilla,” therefore, audit firms prefer your company does some analysis to determine the impact.
The more conservative stance is to look at your data and come up with a fair value before and after the modification on the effective date. This is what we did at Square. This is also where a lot of companies calculate the impact incorrectly. Per the accounting guidance, the modification should be the difference between the fair value before and after the modification, but using the current stock price. We used a firm called Equity Methods to perform the analysis, in which they used a lattice model to measure the probability of different outcomes to come up with an expected stock-based comp charge at the grant level.
Once you have the total stock-based compensation expense you must immediately recognize the amount related to the vested portion of the options. The remainder will be recognized over the individual vesting periods of the remaining options.
New Stock Options Issued After the Effective Date of the Change.
Once you know the effective date of the option extension then you should amend all the option agreements going forward with the same terms. For Square, this did not require any change to the Stock Option Plan itself, but thoroughly check your own as all plans are slightly different.
Most companies also consider switching to restricted stock units (RSUs) immediately after the change so that no more options are being granted. If your startup is in the very early stages and just starting to issue stock options, you can save all this trouble by issuing NQ stock option grants with the extended exercise period already in the grant agreement.
So what happened afterwards?
At Square, we noticed no notable increase in attrition due to the change. No increase. This was a terrific outcome as this was arguably the biggest risk of the whole project. At the time we implemented the change to the exercise period, only one-third of the company had been with Square for more than two years, which helped limit the exposure, but as more and more hit their two year vest, there was still no noticeable increase in attrition.
Understanding the logistics of extending the option exercise period will hopefully open the door for other companies to consider making the change. At Square, the change was overwhelmingly positive. As startups are taking longer and longer to go public, this should be the default, not the exception, for employees that worked so hard to grow the company. It’s time to release the golden handcuffs.
Disclaimer: These are my thoughts and observations regarding this topic and not that of Square. The impact of this change has already been reflected in the company’s latest public filings.
Thank you to my lovely wife, for all her edits and feedback on this and other posts.
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