The NASPP Blog

Two weeks ago, I discussed the Medicare tax rate hike that goes into effect next year (“The Supreme Court and Stock Compenation,” August 7). Today I discuss some additional considerations relating to that tax increase and other possible tax increases for 2013.

A Busier Second Half of the Year

Any time there is a tax rate increase on the horizon, tax advisors get on their soap boxes about accelerating transactions to take advantage of the current lower rates. In our world, that translates to employees possibly exercising their NQSOs this year, rather than waiting until next year or later.

Of course, here we’re only talking about an additional .9% in tax. Generally, tax considerations shouldn’t drive investment decisions and I would think that this is especially the case when we’re taking about such a small increase–on a gain of $1 million, that’s only $9,000 in additional tax. If you think the stock is going to increase in value, I’m not sure it’s worth it to exercise early just to save the $9K.  But Jenn Namazi, the other half of the NASPP Blog, tells me that she has heard several advisors (including some very large, well-respected firms) suggesting this investment/tax strategy, so what do I know?

More Sales

In addition to NQSO exercises, you also may find more of your insiders selling stock in the latter half of this year.  This is because, in addition to the rate hike I described last week, a completely new Medicare tax also goes into effect next year.  This is a 3.8% tax that applies only to “unearned income” in excess of the same $200,000/$250,000 threshold.  Unearned income sounds like something bad, like you it is income you don’t deserve, but it really just refers to income you didn’t earn by toiling away for your employer.  Primarily, this is income from investments, such as capital gains realized on the sales of stock. 

3.8% is a little more significant (actually about four times as significant) than .9% (it amounts to $38,000 on a gain of $1 million). On top of that, if Congress doesn’t take action to extend the Bush-era tax cuts, the long-term capital gains rate is going to increase from 15% to 20%.  Consequently, long-term capital gains that would currently be taxed at 15% might be taxed as high as 23.8% next year.  That’s the sort of tax rate increase that I expect to be more likely to change investment strategies. 

Of course, there’s no tax withholding on long-term capital gains and this applies to the new Medicare supplement as well.  There’s also no matching company payment, so the company doesn’t have any reporting or withholding obligations with respect to this tax.

But, where the sellers are executives, the sales could have other impacts to the company.  At a minimum, the sales have to be reported for Section 16 purposes.  And where executives have Rule 10b5-1 plans set up, you might find a flurry of changes to increase sales under these plans, which most companies would need to review/approve.

Shareholder optics are also a consideration; having several executives (or all executives) suddenly appear to be dumping company stock around year-end may not be the best thing for the company’s stock price.  Your investor relations group may want to get out in front of this one.