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The Curious Case of the Stock Option

young professional woman shaking hands

Over the years I’ve received numerous calls and e-mails from advisors and development officers  with the same question. It goes like this.

“I am working with a business executive who has a lot of stock options. Can she donate those to charity?”

The answer is “usually no”, but they still offer an incredible opportunity for both great tax savings and for charitable giving, so don’t overlook them. I will explain, but first we should make sure we understand what the heck stock options are.

What is a Stock Option, Anyway?

Stock options come in a few varieties, but basically it’s a reward given by a company to employees or others associated with the company. It’s not a share of stock. It’s an option to purchase shares of that company’s stock from the company for less than what they would pay on the open market. The person with the option has the choice to exercise that option or not. Exercise is the technical word for purchase in the world of stock options.

Sounds great, right? It can be a great perk; however, it does come with some potential drawbacks. Let’s explore with an example and show how exercising the options along with a charitable gift of stock can paint a rosier picture.

How it Works.

Heather works as the Chief Financial Officer for XYZ Corporation. As a reward for being such a marvelous employee, XYZ Corp grants Heather the option to purchase 100 shares of XYZ stock for $35/share. The current price of XYZ Corp on the stock market is $50/share. This discount of $15/share is called the “spread”.

If Heather wants to take advantage of this opportunity, it will cost her $3500 to buy 100 shares. It will also trigger income tax. Why is that? The discount is a kind of compensation. Therefore, Heather must recognize income tax in the amount of the discount or “spread”.  If she is in the 35% Federal + State tax bracket, the income tax equals $525.

Total cost to exercise these options = $4,025.

($3500 exercise price + $525 income tax)

Is it worth it for Heather? Should she pay a total of $4,025 for $5,000 worth of stock? She could sell it right away and make a $975 profit. If sold immediately, she could avoid any capital gains tax, because by paying income tax on the spread, she increases her basis to $50/share. If the stock grows in value over time, the profit would increase and she would be subject to capital gains tax when sold at a gain. It could also drop in value. Hmmmmm……what will Heather do?

Heather decides to go forward with the purchase, but because she’s a smart cookie, she adds a twist for a bigger impact. Immediately following the purchase, she sells 75 shares for $3750 and donates the remaining 25 shares to her alma mater, Awesome University, to be used for her favorite scholarship program. That gift entitles her to a $1250 charitable income tax deduction. (25 shares x $50). Her tax savings in a 35% bracket is $437.50. Awesome U sells those shares free of any capital gains tax and uses the $1250 proceeds for the scholarship.

Heather already gives about $1,000 per year to Awesome U every year, but usually from her cash flow. This transaction allows her to give more than she usually does, free-up $1,000 from her cash flow, and result in a small profit. 

Total Benefit After Exercise with Charitable Gift: $1,162.50

Price of shares: $3500 + Income tax on spread: $525 – Charitable Deduction Savings of $437.50 – Sale Price: $3750 – Increased Cash Flow: $1,000


Total Benefit After Exercise with NO Charitable Gift:  $975

Price of shares: $3500 + Income tax on spread: $525 – Sale Price: $5000

If this stuff fascinates you and want to know more about how stock options work, I highly recommend you check out the National Center for Employee Ownership. They publish lots of good articles on owning company stock, including this one that I share with my students when we study stock options. It defines all the terms and outlines the different varieties of stock options out there.

Bottom Line…

You’ve heard me say it before and I’ll say it again. Combining charitable gifts alongside other financial transactions can and does produce marvelous results. Don’t let the opportunity pass you by.

Additionally, fundraising MUST move beyond the checkbook. We must start looking for and listening for opportunities to turn our assets into great gifts. By doing so, we Turn Wealth Into What Matters™.

2 Comments

  1. PATTI KRAMLINGER on October 3, 2018 at 10:15 am

    Dana
    That was terrific. I myself have exercised stock options but did not know how to wade through the process of how the tax and gift. Now I know and this is timely as it is October and in a month or so we will start to see this activity at Mankato Area Foundation.
    Best,
    Patti Kramlinger

    • Dana on October 5, 2018 at 2:50 pm

      Thank you, Patti for your personal story and comments. I’m so glad this was helpful for you!

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