For company or division presidents, heads of departments, chief executives and senior managers who have an Executive Share Scheme (ESS), you’ll be familiar with the term vesting. For those who are new to it, or perhaps a bit rusty on your understanding of the importance of vesting, this article is for you.
For a start, ALL ESS have vestings and when company shares vest, it represents the first point at which you can transact on the shares that have been awarded to you by your company. There can, of course, be considerable personal wealth benefits, and just as considerable tax liabilities. It’s complicated, and the key is to be informed and understand how to make the most of your ESS vesting events.
In Australia, vesting is generally known as the taxing point for shares awarded to you under an ESS, and while there are financial benefits (often considerable) it can create an unfunded tax liability.
It is also common for this tax liability to go unnoticed until the individual lodges their Australian tax return for the year in which the shares have vested. This is due to Australia-specific tax legislation, and is often because there can be considerable time between the company shares vesting and when the tax on those shares falls due for payment.
For example, some companies have shares vesting in July and August each year, and the associated tax bill is usually due in May around 2 years later.
Being aware of your share vesting tax implications is one thing, but there are other important actions that need to be considered and taken.
Those actions will depend on individual circumstances, and qualified and specialised ESS advice specific to you is necessary. However for the purpose of this article I’ve broadly outlined three common considerations.
1: Take no action, allow the shares to vest and retain them as ‘vested’ shares
If you choose to retain your newly vested shares, you will need to consider how best to hold them. This is because the future tax on dividends and capital gains could differ substantially if you continue to hold these in your own name, the name of your spouse, your superannuation or in a different structure like a family trust.
It’s important to note, vesting and exercising shares triggers a tax point that results in a tax liability for the financial year in which the shares vested. Different rules may apply to options and startups, so it’s important you seek advice to ensure your tax specific circumstances are understood.
Among your key considerations will be whether there is a risk of your tax liability at that tax point being greater than the value of the shares which can result from share price suddenly falling in future. This has affected executives in the past where a downturn or unexpected shock (like COVID) saw shares in the company they work for, decrease significantly, in a short period of time.
2: Sell ALL shares at the point of vesting
Selling all vested and exercised shares could be appropriate for you wish to use the proceeds to repay debt, contribute to superannuation or reinvest to other assets for the purpose of diversifying your investment portfolio. From a taxation perspective, it’s important to note, if you sell vested shares within 30 days of vesting, this impacts the value which should be reported to the ATO as income. You can read my earlier article about why it’s important to avoid being top heavy in company shares, here.
3: Sell ‘enough’ shares to cover your unfunded tax liability
As an ESS holder, the assumption is that you are a high income earner paying tax in the top marginal tax bracket. For you, considering selling just enough shares, amounting to 47% of the value of your shares, may help you meet your future unfunded tax liability. You may choose to ‘park’ these proceeds in an interest earning bank account or as an offset to your home loan.
Further, as Australian tax legislation does not require the administrator of your ESS to withhold tax, it may also be appropriate to consider selling a sufficient number of shares for the purpose of covering shares that may have fallen significantly in value.
Detachment is the key
When it comes to selling company shares, some executives have trouble letting go.
It’s not uncommon for executives to have an emotional attachment to their company shares as they may have strong loyalty to the company through which they built their career and personal success.
While the reality of circumstances usually requires some or all shares to be sold, some executives often set what they consider an ‘optimal’ sale share price.
For those who attempt to ‘time the market’ for the purpose of achieving a specific share price, it often ends in tears. As quickly as an optimal price arrives (if it ever does), it’s gone again and before they are able to act.
Inevitably they sell the shares for a lower price and if they sell their entire shareholding in one lower price transaction, it could result in a less than optimal financial outcome.
An alternative is to implement incremental share sales.
Known as dollar cost selling, it allows the share price to fluctuate according to market volatility, rather than being locked-in to a single share price and potentially locked-in the loss of a lower share price.
For example, say you wanted to realise an amount of cash from a shareholding worth $500,000. A 5% increase in value of this shareholding, results in the value increasing by $25,000. You could consider a sale of $25,000 at a price close to current which helps you realise value from your shares, while retaining the same dollar value invested.
While volatility does include some shares selling lower, historically share prices are more frequently higher than lower.
A dollar cost averaging approach is generally more psychologically acceptable for most people as selling everything in one large (and valuable) transaction can be difficult to commit to, and when the time comes to make the call on the sale, the what-ifs often result in them not coming through on the execution of the sale when they should (or the optimal share price being close to, but never being reached). You can read more about dollar cost averaging here.
Next steps
As I mentioned at the outset, ESS vesting is complicated. You’ll need specialised advice, particularly if you are busy, as is the case for most executives and senior managers in positions of responsibility.
The key to enjoying the personal financial benefits of your ESS is to understand and consider your options at vesting to ensure your end position (often at a much later date) is to your advantage and includes covering your tax liability when it is due without financial discomfort or penalty from the ATO.
To find out more about your ESS and vesting options, may I invite you to give me a call on +61 (0) 7 3007 2080 or email contact@executivestrategies.com.au to request a call back.
Executive Strategies is a specialised information hub for executives and senior managers who may have founded their own business or who work for growing private, ASX listed companies or government businesses. Its purpose is to provide access to specialist advisers and information that addresses the often-complex issues affecting their personal prosperity.
James Marshall is a financial adviser and specialised ESS strategist. To learn more about James Marshall, visit this link.
Stratus Financial Group and its advisers are Authorised Representatives of Fortnum Private Wealth ABN 54 139 889 535 AFSL 357306. This advice is general and does not take into account your objectives, financial situation or needs. You should not act on it without first obtaining professional financial advice specific to your circumstances.
Please note: For advice and services relating to this matter that are not offered under the Fortnum Private Wealth AFSL, in accordance with our collaborative advice model, when required, such matters are referred to appropriately qualified professionals.
