TRANSFER OF NON QUALIFIED STOCK OPTIONS
If you own "Non Qualified Stock Options" (NSOs), then this letter is critical for you to read because there is a potential for millions of dollars in estate tax savings! There are two key issues:
1) Discount
What would you pay for a $1,000,000 portfolio of UNVESTED NSOs? Unvested NSOs means that the company has granted stock options to the employee (grantee) but the stock options have not yet "vested." Many NSOs "vest" within 4 years of the grant. But they may never vest if the employee’s services are terminated prior to the vesting date.
Answering the question, What would you pay for highly volatile stock where the right to own it is not certain? "Very little!"
2) Income Tax
When the NSO option is exercised, the gain is taxable to the employee. This means that if the father (employee) donates NSOs to a trust for his children, when he exercises the option, the father pays the income tax on the money his children receive! This "Tax Payment" is a free gift to the children, which results in the funds used to pay the income tax escaping the estate tax system.
These two ideas together result in the savings.
Let's take an example. Assume our client has $1,000,000 of NSOs that are unvested. The IRS has said that a gift of an unvested option is not a completed gift but the courts have said this is wrong. Just because a right is unvested does not mean you cannot give it. The issue is simply the value of the gift.
If we set up a trust for the children and transfer the options to the trust, what is the value of the gift? We would have to ask the underwriter for the company but if it is unvested, it is probably less than $100,000.
This means we could get an asset that may virtually explode in value out of the estate for a very small present value gift. It also means that when the option is exercised the parents pay the income tax, which is another free transfer of funds to the next generation.
If carefully completed, this gift can also qualify for Generation Skipping treatment which means it can be exempt from the transfer tax system for the next 5 generations or so.
In numbers this means that our initial $1,000,000 of NSO stock is gifted using up $100,000 of the donor's Unified Credit. If the donor has a 35-year life expectancy and if the stock only grows at 12%, the fund will be worth $52,000,000 by the time the parent dies.
This means we just SAVED THE HEIRS $26,000,000 in estate taxes.
If the stock explodes like some are doing lately, it may mean a great deal more!
This NSO concept is discussed in an excellent article from the Conspectus Current entitled, "Using Options to Allow Donees to Have the Donor's Cake and Eat it, Too, as well as the "safe harbor" methods from the IRS for valuation. (Rev. Procedure 98-34.) If you would like a copy of the article, please call Diane Hermann at (949) 453-2900 or e-mail her at inquiries@brownstreza.com to request a copy to be faxed or mailed.
A list of our upcoming seminars may be found on our Resources page, on the Estate Planning Learning Center page, or you may call Diane Hermann at (949) 453-2900 or e-mail her at inquiries@brownstreza.com.