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How to track employee stock plans

by Doug Morris, CEO, Sharesight

I spend a lot of time answering investment questions from family, friends, and the occasional ex-girlfriend. The most common phrase is “I’ve got shares through my employer.” These are known as employee share schemes, company stock plans, or share purchase plans.

If you own company shares as part of a bonus plan, you need to track their performance because it has a real impact on your compensation. You’ve got to know what those shares are worth and consider the alternatives because by the time you cash out they may have lost value.

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Most companies offering stock as an incentive fail to provide basic investment advice to their employees. The rationale to provide company shares is sound – work hard and the price goes up.

I recall my experience at Morningstar, whom I joined after university one year prior to their 2005 IPO.

The “advice” I received amounted to a pep talk from the broker handling the employee shares. They assumed I was going to become an overnight millionaire and they were pitching complex financial structures, which (surprise!) needed their expertise.

Putting my 35 shares into a blind trust that automatically sold them to avoid SEC-related conflicts of interest seemed like overkill even then to my 24 year old brain. Given the IPO price of $18.50, $647.50 didn’t seem worth the bother.

Morningstar is an investment research company so most of us understood the basics, but I was reminded recently that most people have no idea how these plans work and how risky they can be.

It’s critical to understand the basics of the two common stock plan types and how vesting works.

Restricted Stock Units (RSUs)

RSUs are the most common and simplest type of employee stock plan. An RSU is basically a cash bonus that is automatically converted into shares. RSUs are pinned to the historical grant price and are released to you over time (a process known as vesting - see below). When the RSUs vest, you’re taxed as if this was normal income. Many employers withhold this automatically, particularly in the US, although in countries where employee shares are not as widespread this is less common.

For example, if I had been given a $1,000 bonus in Morningstar stock on 1 January 2010 when the share price was $50, I would have received 20 shares, but could only act on them after they vested.

From a tax perspective, the vesting date and the sell date are the ones to keep an eye on. To avoid short term capital gains tax, you’ll need to hold onto your shares after they vest for longer than a year (depending on your tax country). Also, if your company pays dividends, you’ll begin receiving them after vesting and need to factor these into your taxable income.

Stock Options

Stock option plans are out of fashion because they’re a nightmare to administer and create tax problems for the recipient, but you may still be a participant. Stock options are shares given to an employee at a specific exercise price. They are also generally a lot more volatile than ordinary shares.

For example, Morningstar gave me 35 stock options at $18.50 in 2005. This meant I had an option to exercise my 35 shares at $18.50 anytime after the vesting date. In my case, all 35 options had vested by 2009 and I exercised and sold them in 2012.

It’s commonly misunderstood that exercising is the same as selling. Exercising an option means you buy them at the agreed price and convert them into shares. . You can choose to hold or sell them. If selling, you’ll probably have the option to do a cashless transaction so you don’t have to front the money to exercise the options before selling.

From a tax perspective, the clock starts usually starts running on the exercise date. You may also be liable to pay income tax on unrealised gains on the shares after exercising them as is the case in the US.

Options usually expire after 10 years as well, meaning you forfeit your right to exercise them if you don’t exercise them before the expiry date. This translates to $0.

You can see how this can become an expensive and complicated process before you receive any cash, and why it’s fallen out of favour!

Vesting

Vesting is the time lag between when you’re awarded the shares and when you can act on them. This is basically a way for the company to mitigate short-term behaviour and keep you around. Vesting usually takes place on a quarterly or annual schedule with portions of the bonus shares being released to you in equal allotments called tranches.

This gets tricky if you’re awarded stock bonuses in consecutive years. For example, if I received 35 Morningstar stock options or the RSU cash equivalent in three straight years, with the tranches vesting in three equal tranches on a yearly basis this means I’d have nine chunks of stock to track:

 20152016201720182019
2015 Bonus
35 Shares
Tranche 1 (11 shares)Tranche 2 (12 shares)Tranche 3 (12 shares)  
2016 Bonus
35 Shares
 Tranche 1 (11 shares)Tranche 2 (12 shares)Tranche 3 (12 shares) 
2017 Bonus
35 Shares
  Tranche 1 (11 shares)Tranche 2 (12 shares)Tranche 3 (12 shares)

In this example, 2017 is a busy year. You’d have three chunks of stock vesting at three different prices. The unequal amount are due to 35 not being divisible by three in whole share terms.

Tracking your employee shares

Do not put this off. The more complex things become the more tempted you’ll be to kick the can down the road. Understanding the market value of your employee shares is crucial to maximising (or salvaging) your hard earned bonus.

The two most common mistakes people make are:

  1. Assuming company stock is the same thing as a free cash bonus.
  2. Assuming the value of the shares will only go up.

They are not free sharess, you’re buying the stock with your bonus.

You are forced to exchange your cash bonus for the equivalent number of shares meaning that it’s certainly more risky than holding cash. Assuming that you’ve bought the shares is the first step towards acting like a proper investor.

Now that you own the shares, you need to keep an eye on their performance.

Stock bonuses get thrown around in pop culture and are assumed to be highly lucrative. Recall the artist who took Facebook shares in exchange for painting their office, or the famed millionaire Wal-Mart custodians. In reality, most people with employee shares work for established companies and are awarded stock long after their IPOs.

Tracking begins with confirming how many shares you own and which ones have vested. Employee share plans are often administered by share registries or back office companies. This means the website you need to use is going to be terrible, but It should tell you how many units you have vested and unvested and what the grant or exercise price is.

To get started, simply enter these as buy trades into Sharesight. All you need are: number of units, price, date. Done.

Here’s how my 35 Morningstar shares performed against the S&P 500:

screenshot - morningstar

I’d recommend using one portfolio for your vested shares and another for the unvested. Or, you can use our custom labels feature to tag each appropriately and keep them in the same portfolio. When the shares are first issued you would buy them in your unvested portfolio. When they vest you sell them out of your unvested portfolio and buy them in your vested portfolio (at the same price and quantity).

Keeping track of these buy trades in the vested portfolio is important because these will generally be reportable as income in the year you “buy” them. By running the all trades report you can retrieve this data. Your company will produce a report which goes to the tax authorities with the taxable amount you have received. This should equal the sum of your buy trades in most cases.

The performance of your unvested shares is something worth keeping an eye on, especially as the vesting date approaches. You have used your bonus to buy these shares so you want to know how they are performing relative to the other investments you could have made with your bonus. This is the “opportunity cost” of owning the company shares.

While tracking the unvested shares is important, once they are vested it’s crucial, because now you have the ability to take action if you wish.

Once a share vests, you are the owner, which means you are now an investor. You can sell for cash or invest elsewhere. You need to begin comparing the company stock performance versus alternatives.

Sharesight will show you annualised performance and let you benchmark your holding against popular indexes. Plus, Sharesight will factor in any dividends received, which can have a big impact on your return. You can also add hypothetical investments to build a “what if?” scenario.

If your vested share bonus is worth the same today as it was when it was awarded (or less), that’s a bad outcome. Putting that money in cash would have at least earned you interest. You ought to diversify away from holding one stock. If you’re new to the market, I’d take a look at investing in an ETF and doing a bit of research on Morningstar’s website.

Also, remember your salary and the company stock price are dependent on the same source. This increases your reliance on that company to survive.

If you do decide to sell your shares, you’ll be responsible for paying the appropriate taxes. Sharesight’s realised and unrealised capital gains tax reports will automatically sort out your gains and losses and when they occurred relevant to the vesting (buy) dates.

This stuff is complicated, but nothing you can’t learn by doing a bit of homework and having a play with Sharesight. We’d also recommend sharing portfolio access with your accountant to make sure everything is correct before filing your taxes.

Important Disclaimer. We don’t provide tax advice. The taxation of employee shares can be complex and varies by country. You should seek tax advice specific to your situation before acting on any of the information in this article.

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