Do You Lose Stock Options When You Leave a Company?

Stock options are a common form of equity compensation, granting an employee the right to purchase a specific number of company shares at a predetermined price, known as the exercise or strike price. This mechanism allows employees to potentially benefit from the company’s growth without immediately owning shares. Many companies include stock options in their compensation packages to attract and retain talent.

Vesting and Forfeiture of Stock Options

Vesting dictates when an employee gains ownership rights to stock options. It is the process of earning equity over time. Unvested options cannot be purchased. The terms of vesting are typically detailed in a stock option agreement.

Common vesting schedules include “cliff vesting” and “graded vesting.” Under cliff vesting, no options vest until a specific period, often one year, has passed. After this initial period, a significant portion or all options may vest at once. Graded vesting allows options to vest in increments over time, such as a percentage vesting each year or monthly after an initial cliff.

When an employee leaves a company, unvested stock options are almost always forfeited. This means any options that have not yet met their vesting requirements at the time of departure are returned to the company.

Exercise Windows and Rules After Departure

Vested stock options can be exercised after leaving a company within a specific timeframe called the post-termination exercise period (PTEP) or exercise window. The length of this window varies depending on the company’s policy and the option type.

There are two primary types of employee stock options: Non-Qualified Stock Options (NSOs) and Incentive Stock Options (ISOs). ISOs generally offer favorable tax treatment, but require exercise within a certain period after employment ends. For ISOs, federal tax regulations typically require exercise within 90 days of departure to maintain tax-advantaged status. If ISOs are not exercised within this 90-day window, they automatically convert to NSOs for tax purposes, losing their preferential tax benefits.

NSOs often provide more flexibility regarding the post-departure exercise window. While some companies may still impose a 90-day window for NSOs, others offer extended periods, ranging from six months to several years. The specific circumstances of an employee’s departure, such as voluntary resignation, involuntary termination, retirement, disability, or death, can also influence the exercise period, with some scenarios potentially offering longer windows or accelerated vesting.

Tax Implications of Exercising Post-Departure

Exercising stock options after leaving a company carries distinct tax implications, depending on the option type. For Non-Qualified Stock Options (NSOs), the difference between the exercise price and the fair market value of the shares on the exercise date is typically taxed as ordinary income. This difference is subject to federal, state, and payroll taxes. If the company is publicly traded, a “cashless exercise” might be possible, where some shares are immediately sold to cover the exercise cost and taxes.

Incentive Stock Options (ISOs) have a different tax treatment. Upon exercise, the “spread” (the difference between the exercise price and the fair market value) is generally not subject to ordinary income tax. However, this spread is considered income for Alternative Minimum Tax (AMT) purposes, which can trigger an AMT liability.

A “disqualifying disposition” of ISOs occurs if the shares acquired through ISO exercise are sold before meeting specific holding period requirements: at least two years from the grant date and one year from the exercise date. In such a case, the tax advantages of ISOs are lost, and the gain is taxed as ordinary income rather than at long-term capital gains rates. The timing of both exercise and subsequent sale significantly impacts the overall tax burden for both NSOs and ISOs.

Key Information from Your Stock Option Agreement

Your individual stock option agreement, also called the grant agreement or plan document, is the definitive source for understanding what happens to your stock options upon leaving a company. This legally binding document outlines the specific terms and conditions of your equity compensation. It is paramount to review this agreement carefully to ascertain your rights and obligations.

Within your stock option agreement, you should look for several pieces of information. It includes the precise type of options granted (ISOs or NSOs), which dictates their tax treatment and post-departure rules. The agreement will also detail your specific vesting schedule, including any cliff periods and the rate at which your options vest over time.

The agreement will specify the exact post-termination exercise windows applicable to your options, potentially varying based on the reason for your departure. It will also outline clauses regarding forfeiture of unvested options or company repurchase rights.