What Happens to Stock Options If You Get Fired?

Understanding how stock options are handled when employment ends is important for financial planning. Company-specific documents outline the details governing these equity awards upon departure. Navigating these provisions helps individuals make informed decisions about their potential equity.

Understanding Stock Options and Vesting

Stock options grant an employee the right to purchase company shares at a predetermined exercise or strike price, usually set at the fair market value on the grant date. The value of an option depends on the company’s share price increasing above the exercise price.

Before an employee can exercise stock options, they must “vest,” meaning they earn the right to ownership over time or by meeting specific conditions. Vesting schedules are commonly time-based, like a four-year plan with a one-year “cliff” where no options vest until one year of service is complete, then gradually over subsequent years.

There are two primary types of stock options: Incentive Stock Options (ISOs) and Non-qualified Stock Options (NSOs). ISOs are reserved exclusively for employees and can offer favorable tax treatment if specific holding period requirements are met. NSOs can be granted to employees, contractors, advisors, and other service providers.

The key distinction between ISOs and NSOs lies in when and how they are taxed. For NSOs, the difference between the fair market value of the shares at exercise and the exercise price is taxed as ordinary income at the time of exercise. In contrast, ISOs do not trigger ordinary income tax at exercise, though they can have implications for the Alternative Minimum Tax (AMT).

How Termination Affects Your Options

Upon employment termination, stock option status changes, distinguishing between unvested and vested portions. Unvested stock options are forfeited immediately upon termination.

Vested options have a limited “post-termination exercise period” (PTEP). This period is often 90 days, though it can vary based on the company’s plan document. If vested options are not exercised within this window, they will expire and return to the company’s option pool.

The reason for termination can impact the PTEP and the fate of vested options. If an employee is terminated “for cause,” such as for misconduct or policy violations, companies often have the right to revoke all vested and unvested options immediately, potentially leaving the employee with nothing.

Conversely, for terminations “without cause,” voluntary resignations, or retirement, the standard PTEP applies. In instances of death or disability, the post-termination exercise period is often more generous, commonly extending to 12 months or even longer, providing beneficiaries or the disabled individual more time to act.

Key Information in Your Plan Document

The specific rules governing your stock options, particularly upon termination, are detailed in your company’s Stock Option Plan Document or Award Agreement. These documents define your contractual rights regarding equity compensation. Review these materials to understand the precise terms applicable to your situation.

Within these documents, several clauses warrant close attention. Look for definitions of “vesting” and “termination,” as these terms dictate when options become exercisable and how different types of employment separation are treated.

The document will specify the exact post-termination exercise windows for various scenarios, such as voluntary resignation, involuntary termination (with or without cause), retirement, death, or disability. These periods can range from a few months to several years, with some companies offering extended windows beyond the common 90 days.

Additionally, scrutinize provisions related to “clawbacks” or other forfeiture conditions. Some plans may include clauses allowing the company to reclaim previously vested options or profits under certain circumstances, such as a breach of non-compete agreements or post-employment misconduct.

Information on how to access your specific plan document, often through Human Resources or a company-provided online portal, will also be outlined. Understanding these details before an employment change occurs can help avoid unexpected forfeiture of valuable equity.

Steps to Exercise Vested Options After Termination

After identifying the post-termination exercise period for your vested options, contact the plan administrator, which could be an internal HR department or an external brokerage firm. Many companies provide an online portal where you can initiate the exercise request.

You will need to pay the exercise price for the shares you wish to acquire. Common payment methods include using cash. Another method is a “cashless exercise” or “same-day sale,” where a portion of the shares being exercised are immediately sold to cover the exercise price, taxes, and any associated fees. The remaining shares, or the cash proceeds from their sale, are then remitted to you.

A “sell-to-cover” method is similar, where only enough shares are sold to cover the exercise costs and taxes, with the remaining shares delivered to your brokerage account. Adhere strictly to the post-termination exercise deadline specified in your plan document. Missing this deadline will result in the forfeiture of your vested, unexercised options. After the exercise is complete, the shares are issued and become yours.

Tax Considerations and Seeking Advice

Exercising stock options carries significant tax implications that vary based on the option type. For Non-qualified Stock Options (NSOs), the difference between the fair market value of the stock at exercise and the exercise price is taxed as ordinary income. This amount is subject to federal income tax, Social Security, and Medicare taxes, and it is reported on your Form W-2 for employees.

Incentive Stock Options (ISOs) receive different tax treatment. There is no ordinary income tax due at the time of exercise for ISOs. However, the spread between the exercise price and the fair market value at exercise is considered income for Alternative Minimum Tax (AMT) purposes. This can trigger an AMT liability, requiring careful tax planning.

When shares acquired through NSOs or ISOs are later sold, any further appreciation or depreciation is subject to capital gains or losses. The holding period of the shares (held for over one year) determines if the gain is short-term (ordinary income rates) or long-term (lower capital gains rates). For ISOs, meeting specific holding periods (more than one year after exercise and two years after grant) is essential to qualify for favorable long-term capital gains treatment.

Given the complexities of stock option taxation, consulting with a qualified tax advisor or financial planner is highly recommended. These professionals can provide personalized guidance, help navigate the tax implications, and assist with tax planning strategies to minimize potential tax burdens. They can also clarify the specific reporting requirements and help ensure compliance with tax laws.