Stock options and estate planning

Vested vs. unvested stock options: a quick primer

Stock options are a right (not an obligation) to buy a set number of shares at a predetermined price within a certain timeframe. That price is referred to as the exercise price. Companies often grant options as part of employee compensation.

Vested options are those the employee has earned. They have met the required service time, performance goals or other conditions. The employee has the legal right to exercise these options according to the plan rules.

Unvested options are still subject to forfeiture. If the employee dies, resigns or is terminated before the vesting conditions are met, unvested options are often (but not always) lost.

What happens to vested options at death?

Typically, vested stock options do not expire immediately on death. However, most option plans impose a tight window for the estate to act — typically from 90 days to one year from the date of death.

Executors must:

• Identify the option and quickly locate plan documents, award agreements and any amendments.
• Understand the plan terms. For example, some plans automatically accelerate vesting at death while other plans do not.
• Decide whether to exercise. If that’s the decision, the estate may need to pay the exercise price and deal with the tax implications before selling the shares.
• File appropriate paperwork. That means notifying the company, submitting proof of death and providing estate authorization documents.

If the deadline is missed, the options typically expire and are worthless.

What about unvested options?

In most cases, unvested options are forfeited at death unless the stock plan specifically states otherwise.

Some companies will accelerate vesting upon death as a goodwill or employee-benefit policy. Some allow discretionary acceleration by the company’s board of directors or compensation committees. And some offer partial acceleration, based on years of service or performance milestones achieved.

Executors cannot assume unvested options are automatically worthless. They must review the plan carefully and engage with the deceased’s former employer’s HR or stock plan administrator. If possible, advocate and or petition for acceleration.

Failing to do so could mean missing out on valuable company equity that rightfully belongs to the estate and its beneficiaries.

Tax implications

Exercising stock options triggers tax consequences, even for a client who has passed.

Four important considerations:

• In Canada, if an employee dies holding vested stock options in a public company, exercising the options typically triggers a taxable employment benefit equal to the difference between the exercise price and the fair market value (FMV) of the shares at exercise. This income must be reported on the terminal T1 return.

• If conditions are met (i.e., the exercise price was not lower than FMV at grant), a 50% employee stock option deduction may be available.
• The executor must carefully time the exercise and sale to avoid exposure to market declines between exercising the options and disposing the shares.
• Some employers may require immediate tax withholding at exercise, adding cash flow pressure on the estate.

Executors should work closely with financial advisors, accountants and tax advisors to model the tax impact before exercising options.

Options in private companies add another layer of complexity:

• There may be no liquid market for the shares after exercise.
• Shareholder agreements or company bylaws may impose transfer restrictions or require a sale back to the company.
• Valuation disputes may arise — especially where beneficiaries believe the company undervalued the shares at repurchase.

Case study

An advisor got a call from the executor of a longtime client’s estate. He expected to help transfer investment accounts and wrap up routine matters. But during a casual conversation, the executor mentioned the deceased had “something with stock options” at his former employer — a fast-growing tech firm.

That offhand comment turned out to be a goldmine. The advisor knew the client had worked at the firm for years and had once shared details of his options.

With the executor’s permission, the advisor reached out to the company and determined that the deceased client had vested stock option grants from his employer, which had not yet been transferred or exercised.

The client had 5,000 vested options at an exercise price of $30. The current market price of the stock was $80. The stock options were set to expire 90 days after death.

The intrinsic value, per options was $50 ($80 – $30). That put the total value of the options at $250,000 (5,000 x $50).

Stock options can be a valuable but precarious part of an estate. Deadlines are often short, tax implications are complex and unvested awards require delicate handling. Those unexercised options that would have expired were completely overlooked in the original list of estate assets. Situations like this aren’t rare, they are just rarely caught.

For executors, the key is early detection, thorough understanding and decisive action. By approaching stock options with urgency and care, executors can preserve what may be one of the estate’s most significant hidden assets and fulfill their duty to beneficiaries with confidence.

For advisors the case shows why it’s critical for advisors to flag and discuss stock-based compensation early. Advisors who ask the right questions about vesting schedules, plan rules and death provisions can help clients protect major sources of wealth, strengthen client relationships and demonstrate proactive value that goes far beyond simple investment advice.

Michael Kulbak, MBA, CPA, CMA, TEP, is principal of Kulbak Trust Solutions in Mississauga, Ont.