tax advice on stock options please!!

Annie2003

I've inherited 6000 fully vested US company stock options five years ago (not approved by Inland Revenue in the UK). Those options will expire in 2013. The paper gain is around $80K, really like to know the 'real gain' after tax. I'd be grateful for any advice on the tax-planning by excising those options. I found an old thread here, maybe there is something new I need to know.

jimmo

I have been keeping an eye on this thread hoping to see some good advice. But it hasn’t happened yet.
I like to think I know a fair bit about options and Capital Gains Tax but I am really struggling to understand your question.
When you say that you inherited company stock options, not approved by Inland Revenue, the approved/ not approved bit sounds to me to be a reference to possible Income Tax liability on the granting of the option.
Sorry, but tax really is personal, If an option was granted to someone who has since died and you have inherited the option the question of whether the option was part of an approved scheme or not is not directly relevant to you. The original grantee may, or may not have had an Income Tax liability on the grant of the option but that is nothing to do with you.
If I am reading this correctly when the person died the option itself was a capital asset and passed to you at its open market value at the date of death.
Actually establishing the open market value of the option at the date of death really requires significant professional expertise.
Now, if you can sell the option you will be faced with a Capital Gain based on the increase in value of the option from the date of death to the date you sell it.
If you exercise the option, buy the shares or stock and then sell the shares or stock your Capital Gain will be based on the difference between the market value of the option at the date of death plus the amount paid by you in exercising the option against the net proceeds of sale.
Hope that makes sense but if it doesn’t then I think you really have to explain your circumstances in much greater detail.

Annie2003

Thank you, thought no one will reply.

I misunderstood the concept of ‘approved/unapproved by inland revenue’ because theoptions are not part of company save scheme. They are just the right to buy company shares at fixed price some years later. The options was vested instantly because of the death. As for your mail, am I right to think
1. the options became an asset when I’ve inherited, so capital tax is only the tax due.
2. the value of the options is the net difference of the share price and option price to buy.
3. the capital gain tax will be calculated based on the net gain of option price&current share price less the value of the options.

The options are held in a US broker account appointed by the company. With a few glances of PAYE showing in payslips till now, can you advice on:

What I am going to expect after the broker excises the options?
Am I paying the tax or the broker is paying on my behalf?
How do I calculate the tax due?

jimmo

At the moment we are almost not talking the same language but, hopefully we will get closer.
The basic principles, as I see them, are:

Options are capital assets.
When the previous owner of the options died the options passed to you at their open market value.
So, on the date the person died you legally acquired a capital asset, the options for their open market value on that day.
Your idea that the market value of the options on the date you acquired is the difference between the share price and the option price sounds very sensible to me. However, in my working days I would always have to refer that valuation to Shares Valuation Division. So, sorry but no guarantees from me on this.
If you exercise the option, what you actually do is to transform the option into shares. You then have to pay the option price and you end up with a new capital asset, the shares which cost you the sum of the acquisition value of the option plus the option price. Up to now, there is absolutely no UK Income Tax or Capital Gains Tax to consider.
If you then sell the shares you will realise a Capital Gain based on the difference between your acquisition cost and your disposal proceeds.
In my experience all sorts of things can happen when you exercise options. It is not uncommon for someone such as the company or, indeed the brokers, to lend you the money to enable you to exercise the option on the basis that as soon as you exercise the option you will sell the shares and repay their loan. In effect you could borrow the money for a matter of seconds at nil or minimal cost but the principles I have outlined above will apply.
When it comes to tax planning there are all sorts of options that may be available to you mainly dependant on
Whether you have to exercise the options in one hit or are able to exercise some of the options now, some next year etc.
Whether you need to borrow money to exercise the option.
The amounts involved.
How comfortable are you with publishing figures?
Two points to finish,
Your reference to “a few glances of PAYE showing in payslips till now” is really puzzling. Pay As You Earn applies in the UK to wages and pensions paid in the UK. I really cannot imagine how some American brokers are operating PAYE on anything. Have you got things right?
The brokers are exactly that. They do not exercise options themselves. They act on your behalf. You own the options and only you can exercise them.

Annie2003

Sorry about the ‘PAYE’ part, it meant all my knowledge about tax. Ever since I wanted to do something about the options, I have been trying to learn – sometimes just lost the direction to look for the right nformation.

With the basic principles you mentioned,

First, I need approach the Shares Valuation Division. Is it before or after excising the options? Where can I find it and how long it takes to get the valuation?

Second, by borrowing the capital to buy the shares at option price will not attract the capital tax and income tax at this stage; the tax is only due on the net gain when I sell the shares (share price less option price, broker charges, loan interest).

And I don’t have to sell it in one go after having lived like I don’t have it for a while. What do you mean about publishing figures? Do you mean those money questions appeared in newspapers with advice from experts? Thank you for your time and being patient with me, I will learn more.

stan707

I wont pretend to be an expert on these matters but can add the following.
I also have stock options with a US company. As stated above it is usual to exercise and sell without the need to dip in you own pocket. Normally the resultant amount is the capital gain and both US and UK tax will be payable. Yours are inherited so maybe not as clear - I can't comment on that.
Also,NI and employers NI contributions are payable. I suspect you will be left with approx 50%.Stan

Annie2003

Thank you Stan707. Any advice is helpful to me now. Will the NI, employer NI contributions be paid through my employer payroll? Thought only need to pay capital gain tax here after filled W-8BEN.

Londonboy_3

Annie2003

This is quite an unusual situation as every stock option plan I have seen has the stock options vest immediately when the person they were granted to dies. This means that on the date of death, the option is automatically exercised and where unapproved are subject to income tax and national insurance, based on the following:

Market value on date of exercise - amount paid (ie the option price, which is usually the market price on the date the options were awarded) = amount subject to tax and NI.

This means the options turn into shares and you are left with 59% of the original amount (in your case approx $80k) if you are a higher rate tax payer (40% tax plus 1% NIC). If you sell the shares on the same day, there is no capital gains tax to pay. You will only pay capital gains tax if you hold on to the shares, and the value of the shares increases compared to the market value of the shares when they vested and were automatically exercised. If you then sell, then you will pay capital gains tax based on:

Market value on date you sell the shares - market value on date of exercise.

Your opening email however suggests that the option plan in question has a clause that allows the option itself to be passed to you. If it is still an option you will need to exercise it before it lapses in 2013. As you are not an employee of the company i cannot see how practically the company can withhold any tax on the exercise of the option. You should note that it is very unlikely there will be a US tax obligation on these, as you are (I assume) a UK tax resident.

I would try and speak to someone in employment taxes at the US company in question, and ask them to explain how to proceed practically. In terms of how much you will end up with after taxes, the most you are likely to suffer is 41%. If the company cannot withhold on the exercise of the option you will need to declare this on a self assessment tax return as 'other income' and I would keep 41% aside to settle this.

jimmo

Interesting contributions from stan707 and Londonboy. They brought up points that I had not thought of. That is one of the benefits of sites like this. If someone gives incorrect or incomplete advice there’s a good chance that someone else will join in.
I took it at face value that you actually inherited stock options. Londonboy’s explanation of what happens when somebody dies makes a lot of sense to me but I really don’t know whether it is correct.
Taking events in chronological order I assume that:
The deceased, in the course of his employment, was granted an option.
Because the scheme under which the option was granted was not approved by HMRC then if he exercised the option there would have been liability to Income Tax and NIC.
If, as Londonboy suggests, his death automatically triggered the exercise of the option then there is liability to tax and NIC but the responsibility for paying this rests with his estate, not you personally.
If that is the case you actually inherited shares, not the options.
If you are the executor or administrator of his estate then you really have to ensure that you understand that you have separate roles and responsibilities. You, the executor, have to ensure that the estate meets all the estate’s liabilities and obligations and then distribute the balance of the estate to the beneficiaries.
You, as a beneficiary, are simply entitled to what you have inherited.
Just to complete the gobbledegook, if you as an executor get this wrong then you, as a beneficiary, could sue you, the executor, for negligence.
Unfortunately, you cannot approach Shares Valuation Division direct. You can only approach your own Inspector of Taxes but no-one from HMRC is going to be interested until such time that tax is at stake, normally after you have actually sold whatever capital asset you now hold.
Yes, if you borrow the capital to buy the shares at option price there will be no tax charge on that.
Whether you have to sell in one go is governed by the terms and conditions of the option.
I haven‘t read money questions in newspapers for years. But my guess is that I am asking the same thing or probably more.
There are so many variables in your situation so far that, quite frankly, it is impossible to come up with a comprehensive answer.
It would just be so much less complicated if we knew whether you are the widow of the deceased, an executor, or simply a beneficiary.
I can think of lots of other questions I could ask but at the moment they all start with “What if?”
No promises, but I really can envisage a situation where you can plan to get the full $80,000 into your bank account tax free. It could take a few years and it could be better for you personally to take a tax hit and get the net cash into your bank account earlier.
So, I think you have to decide. Tax really is personal and in your situation I think you really have to choose between opening up on here and getting professional advice.

Annie2003

Thank you Londonboy and Jimmo for your reply.
Sorry for the confusion, Jimmo, just don’t know the right words & details to raise this question.
The options belonged to my late husband. Apart from two joint bank accounts, the options were the only one in his name and we didn’t own any property. The HR department transferred the options to me, together with a broker account, and W-8BEN to sign two years ago.

jimmo

If your husband had exercised the options there would have been a charge to UK Income Tax on him on the “benefit”. That charge would have arisen as the benefit was from his employment. However you are actually going to exercise the options and they did not arise from your employment. Therefore there is nothing for the UK taxman to charge.
For the same reason I cannot imagine that the US authorities can charge you either, but I’m really no expert on US taxation.
For UK Tax you really only have to worry about Capital Gains Tax and you seem to already have the basics of the calculation of the amount of the Capital Gain.
Just for the sake of illustration if we assume your gain is going to be $80K and the exchange rate is $2 to £1 your gain is going to be £40,000.
For 2008/09 the personal exemption from Capital Gains is £9,600
Leaving £30,400 chargeable to tax at 18% = £5,472.
I really don’t believe the US authorities can charge you Capital Gains Tax either because you are not a resident of the USA.
The following link is to the relevant HMRC Instruction Book.
http://www.hmrc.gov.uk/manuals/dtmanual/DT19871.htm
Now, if the options allow you to do this, there is nothing with exercising so many options as produce a Capital Gain of £9,600 this year. That will be covered by your annual exemption and you will pay no Capital Gains Tax.
Next year you do the same thing and so on until you clear the lot.
The drawback is obviously that it takes more time for you to get all the money into your hands.
You really should check with the brokers about the US tax situation but remember if the US charges you Income Tax there will be no corresponding Income Tax charge in the UK so you will not be able to claim Double Taxation Relief.
If the US charges you Capital Gains Tax and you exercise all the options this year you will be able to claim Double Taxation Relief. In rough and ready terms if the US charges you 15% then you will pay (18% - 15%) = 3% in the UK.
Hope that helps.