Most Stock Option Plans contain a valuable feature, known as a Stock Appreciation Right. An SAR gives the employee the right to receive the value of the appreciation in the underlying stock that occurred from the date the right was granted up to the date of exercise. Therefore, the employee could obtain a benefit from a stock’s growth without having to actually purchase the stock. This, in turn, provides the employee a source of funds with which to exercise the options.

If the SAR is applicable, the executive management group may receive either stock or cash. The remainder of the management group would receive only shares of stock that may be sold if cash is required.

As stock options are granted, some may contain the SAR feature. This would most likely be for those officers who fall under Rule 16B of the Securities Exchange Commission that prohibits certain stock transactions.

Rule 16B prohibits an individual from making both a sale and purchase of employer stock within any six month and one-day period. Therefore, an officer could exercise an option that is considered a purchase, but would not be able to sell for six months. This places officers in a precarious position.

When a non-qualified stock option is exercised, the officer purchasing stock will receive a gain, taxable as ordinary income (subject to maximum federal tax, as well as any applicable State income tax and any local income tax) for an amount equal to the spread between the option price and the market value of the stock at the time exercised.

At that time, however, one must wait six months and a day to sell. If one decides to sell the shares, this will have additional tax effect. If the stock has risen there is capital appreciation that is again subject to ordinary taxation. On the other hand, if the market price has declined, the result will be a capital loss.

Capital losses are deductible against ordinary income of up to $3,000 per year and may be carried over indefinitely.

These SAR’s fully vest one year from the date of grant, and may be exercised any time thereafter by an active employee within the ten year period. Should your employment terminate for a reason other than retirement, any outstanding SAR’s must be exercised within three months. Should you retire, you will have twelve months following the date of retirement.

The gain on the shares will be ordinary earned income when exercised. The company is required to collect the withholding tax, and you will have to report the balance when filing your personal tax return.

Since you have the right to designate a beneficiary and to exercise or not exercise an option, the value of the SAR’s will be includable in your estate.

When retirement is near, the best strategy would appear to be to wait the maximum period of time - twelve months following the date of retirement. The theory is that the stock should reach its peak at that time if the price continues to rise.

However, younger employees will base their strategy on the rise or fall in the market and their "guess" as to the future stock levels. It should be realized that if a Stock Appreciation Right is exercised in the first year, it will be more valuable than in the tenth year should the market price remain constant. This is because dividends would be earned during the elapsing years.

For example, if an option for 1,000 shares is executed with a gain of $10,000, there would be taxes of $3,500 in a 35% state and federal tax bracket, leaving $6,500 in remaining share value.

These shares would produce dividend income for the succeeding years. The value of those dividends compounded at 6% would become substantial after eight years. Thus, the market price would have to increase substantially by the end of the tenth year for the net value of the option to exceed the value of the stock acquired at the end of two years plus the earned dividends.

SAR’s may be granted in connection with any stock option offered since 1977. This feature may be applied either at the time of the grant of the option or later during the term of the option.

The executive management group and officers may receive cash or stock upon exercising the SAR’s. At the time of exercising, the withholding tax must be paid in cash. This is the only cash required.

Participants may apply for exercise of Stock Appreciation Rights at any time that the related stock option is exercisable. However, participants who are subject to provisions of Section 16 of the Securities Exchange Act of 1934 may make application for exercise only during the period beginning with the third business day following the date of public announcement of the quarterly or annual earnings of the company, and ending on the twelfth business day following such date.

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