Q. Shares of my employer's stock are at an all-time high and I have an option that just vested worth ~$250k. I am happy with the current price but doubt it will last so I am ready to exercise the options. However, with the change in calendar year, I am wondering if waiting until 2014 would be better tax wise. I wouldn't have to pay the taxesuntil April of 2015. I estimate my non-option income will be roughly the same in '14 as it was in '13 ( ~$360k). What should I be thinking about? Best — P.S.R.
A. The two main drivers on this decision are the stock price and taxes. You already have an opinion on the stock price.
For the taxes, a cornerstone of year-end planningis choosing in which year to incur taxable income and deductible expenses. This principle applies to taxpayers of all income levels. I will go with your assumption that your non-option income will be the same in both years. We want to think about income and deductions.
Being December, there is not much guesswork for 2013. If you were confident that more vested options would be worth exercising in 2014, you may want to cash out this 250k in 2013 so only those additional options would be hitting in 2014. For deductions, think about any deductible expenses that may be higher in 2014 versus 2013 like charitable contributions. If you were planning to make donations of some size in 2014, it may help a little to wait until after Jan. 1 to exercise.
Sometimes there is no clarity on which year would be better. If it isn't clear, exercising now alleviates the concern about a pull back in the stock price.
If you don't have anything else coming up in 2014, you might only cash out some this year. For federal, taxable income over 400k (398,350 to be exact) is taxed at 35% up to $450k and then 39.6% above 450k. The proceeds from these "non-qualified" options is taxed as wage income so it is not subject to the new 3.8% taxes on net investment income but is subject to 0.9% of Medicare taxes.
So let's pretend you have no deductions or exemptions and all $360,000 is taxable as wages. If 250k in proceeds from options is exercised in 2013, the first 40k ($400k-$360) will be taxed at 33%, the next 50k costs 35%, and the remaining 160k gets hit at 39.6% That totals roughly $94,000 in taxes ($13,200+$17,500+$63,360).
But, if you exercise $90k this year and the remaining $160k on Jan. 2, 2014, you'll pay about $30,700 in 2013, and $58,420 (30.7+27.72) for a total of $89,120. To make the calculation a little simpler, I did not use the tax brackets for 2014 so the 2014 estimate of the taxes is a bit high but you get the idea.
If you have some deductible expenses you could incur in 2013 or 2014 like charitable contributions or real estate taxes, you could exercise more than 90k in 2013 and maintain the effect. It can get complex, particularly since as your AGI increases the allowed deductions decrease but it can be worth taking the time to work through some projections to assess the tax effect.
Clearly if you delay and the stock price falls enough, you won't net as much. You can quantify how far the stock would need to decline to wipe out the tax advantage of splitting the exercise.
One final note, when you exercise, funds will be automatically withheld for taxes so you won't be able to keep the taxes due for yourself until April of 2015.
Q. Hopefully you can help me with a Social Security question for a client of mine. The wife will be 63 in March 2014 and is considering collecting SS benefits then. Her benefit would be $900 per month. Her husband is also 63 and will continue working. At age 66 his estimated benefit will be $2,650. When the husband reaches age 66, will the wife receive a spousal benefit of $1,325 (50% of $2,650) or will that be reduced because she took her benefit earlier under her own account. Social security told her that her reduced benefit from claiming early was about 80% of her total benefit and that her spousal benefit would be 80% of $1,325 or $1,060 — not $1,325. Is that true? Should she take her benefit early anyhow? Thanks for your help. — Frank H, CPA
A. That is about right. Spousal benefits can be confusing to a lot of people because the quick description is "a spouse can get 1/2 as a spousal benefit." Technically, the spousal benefit is a supplement equal to 1/2 of the husband's Primary Insurance Amount (PIA) less the PIA of the wife claiming the spousal benefit. If this is a positive number, is claimed at or after the wife's FRA, and the husband has claimed his retirement benefit, this supplemental amount is added to the wife's retirement benefit.
If she follows through on her plan, she will be claiming early, her retirement benefit is reduced from her PIA. When she claims the spousal at her FRA, the supplement is added to her reduced retirement benefit so the total won't equal half his PIA.
As to when they should claim, there are several factors, life expectancy being a big one. Generally if either is expected to have longevity, delaying the highest benefit is often preferred. Starting early for her can be good since if either passes away the survivor will only get the husband's benefit since it is larger. In other words, at the first death, benefits from her record end.
At his FRA, he can file and suspend making her eligible to receive a spousal while still allowing his retirement benefit to accrue delayed credits. As an alternative to file and suspend, he could file a restricted application. This would get them delayed credits but he would get a spousal of 1/2 her retirement.
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