Estate Planning for Founders With Vesting Equity or Stock Options
Keep equity usable after death or incapacity.
Planning for Stock Options and Founder Shares
If you pass away or can’t make decisions for yourself, your stock options and shares don’t automatically go to your family like money in a bank account. What your family gets depends on your company’s rules, your personal legal plans, and tax laws. Estate planning helps make sure your company shares go to the people you choose. It also helps them use the shares before any company deadlines.
Founders usually have questions about their shares after getting new funding, receiving more stock, or after a big life event. You might ask who gets your shares, if they can be put in a trust, or what taxes will be due. If you don’t have a good plan, your shares could become worthless, cause surprise tax bills, or go to the wrong people.
This type of planning involves making sure your will or trust works together with your company’s shareholder agreements and option plans. Kevin C. Martin, Attorney at Law, PLLC, helps founders in Washington, DC, create estate plans that manage private company equity. We help coordinate these assets with your existing estate documents to ensure ownership passes according to your wishes.
How Stock Options and RSUs Are Treated After Death
Stock options and restricted stock units (RSUs) are handled through contract law first, and then through probate law. In Washington, DC, the person managing the estate (called the personal representative) follows the rules in the will, trust, and any valid contracts. Stock options and RSUs are a type of contract-based payment.
This means the company’s equity plan and grant agreement decide if these rights continue after someone dies, whether they can be used, and how long the deadlines are. A will or trust decides who gets the benefits, but the company’s rules decide if those benefits are still available.
What Happens to Stock Options
A stock option is a right to buy shares at a set price. After a person passes away, stock options are divided into two types: unvested options and vested options.
Unvested Stock Options
Most equity plans state that unvested stock options are canceled when a person dies, unless the plan or agreement specifically allows for them to vest early. This is called accelerated vesting, where the options vest immediately. However, this is not automatically required by law. It must be written into the plan or agreement. If there is no clause for accelerated vesting, the unvested options are canceled and do not become part of the person’s estate.
Vested Stock Options
Vested stock options are usually considered part of a person’s estate and can be used by their personal representative or trustee. However, the representative must follow the company’s rules. Many companies only give a short amount of time to use vested options after someone passes away. If the representative does not act within this time, the options will expire.
To use the options, the representative must pay the exercise price. They may also have to pay ordinary income tax on the difference between the exercise price and the stock’s value when the options are used. The tax rules depend on whether the stock option is a nonqualified stock option (NSO) or an incentive stock option (ISO).
Some companies also have rules that limit transferring options or allow the company to buy back shares after the options are used. These rules are part of the contract and cannot be changed, even by probate law.
Why the Plan Documents Matter
Under DC law, the personal representative must follow the agreements in the company’s equity plan or grant document. A will or trust cannot change the rules or deadlines set by the plan. If the plan has rules about who can use the option or sets a deadline, those rules must be followed. If the deadline is missed, the options will expire, even if the will says they should go to someone specific.
What Happens to RSUs
RSUs, or Restricted Stock Units, are rights to get company shares after meeting certain conditions, like vesting.
-
Unvested RSUs: Most RSU agreements say that unvested RSUs are canceled if the person dies. Some agreements allow unvested RSUs to vest immediately after death, but this only happens if it is written in the agreement. If there is no acceleration clause, unvested RSUs do not go to the person’s estate.
-
Vested RSUs: Once RSUs are vested and the shares are issued, they become the person’s property. These shares are part of the estate and are given to beneficiaries according to the person’s will or trust. The estate must calculate the value of these shares on the date of death for federal estate tax purposes. In Washington, DC, the value of the shares is also included in the state’s estate tax calculation, which has a lower exemption limit than federal law.
By following the company’s equity plan and agreements, the personal representative can make sure all rules are followed and the estate keeps these valuable assets.
How to Organize Vesting Equity in an Estate Plan
Managing equity compensation requires careful planning to make sure your estate documents match your company’s rules. In Washington, DC, a personal representative (the person handling your estate) must follow your will, trust, and any agreements tied to your assets.
Stock plans, grant agreements, and shareholder agreements often come with specific rules about transferring, exercising, or valuing equity. By planning ahead, you can ensure your estate plan works smoothly with these agreements.
Step 1: Make a List of All Your Equity
Start by listing all the equity you own, like stock options, restricted stock units (RSUs), restricted shares, or founder shares. Include details such as the number of shares, vesting schedule, grant date, and exercise price.
Gather key documents, including:
-
Equity incentive plans
-
Grant agreements
-
Shareholder or operating agreements
-
Buy-sell or repurchase provisions
These documents explain important rules, like how shares vest, limits on transferring equity, and what happens if you pass away. In DC, the personal representative will need these records to manage your equity properly. An accurate list ensures your estate plan covers each asset correctly.
Step 2: Check Your Company’s Rules for Transfers or Buybacks
Private companies often have rules about what happens to equity when someone dies. For example, shareholder agreements might require the company to buy back shares, limit who can inherit them, or prevent transfers to certain people or trusts. Similarly, stock option plans may set deadlines for exercising options or restrict who can receive them.
Review the agreements for rules about death, disability, or leaving the company. These rules might include:
-
Requiring the company to buy back shares at fair market value
-
Limiting transfers to family members or trusts
-
Setting deadlines for exercising stock options
-
Defining how share value is calculated
DC probate law requires the estate to follow these rules. Knowing these rules beforehand helps you plan your estate. You can decide if your heirs will get the actual shares, cash from a company buyback, or just the ability to use the stock options for a limited time.
Step 3: Review Beneficiary and Ownership Designations
Some equity plans allow you to name a beneficiary for shares or options that you already own. If your plan allows this, filling out the beneficiary form lets the shares go directly to the person you choose. This helps avoid the long process of probate. However, not all plans offer this option. Many private company plans require the equity to go through your estate, where it is managed by a personal representative or trustee.
If your plan does not allow you to name a beneficiary, your will or trust decides who gets the equity. In Washington, DC, any assets that go through probate must be managed by a personal representative and given out according to your will.
Step 4: Consider Using a Revocable Trust
A revocable living trust can be a useful tool for holding shares in private companies. In Washington, DC, putting assets into a revocable trust can help avoid probate. A successor trustee can manage the assets without needing the court’s help.
Before transferring equity into a trust, make sure to review your company’s rules. Some shareholder agreements require company approval before you can transfer shares to a trust. In some cases, trusts can hold vested shares but not unexercised stock options. If allowed, placing equity into a trust can make managing assets easier. It also allows the trustee to handle shares or exercise options for the beneficiaries.
Step 5: Plan for Taxes and Liquidity
When you get paid in company stock, it can lead to taxes. For example, if you use stock options, you’ll be taxed on the profit you make. Vested shares and RSUs are also counted as part of your estate for federal estate taxes. Washington, D.C., also has its own estate tax if your estate is large enough.
Your estate plan needs to cover how to pay for these taxes and any costs to exercise options. You could set aside cash, arrange a buy-sell agreement with the company, or use life insurance. If you don’t have a plan for these costs, your heirs might not be able to exercise your stock options. They might also have to sell shares quickly just to pay the taxes.
When and How Heirs Can Exercise or Sell Equity
When someone inherits stock options or shares, there are specific rules and deadlines they must follow. These rules are set by the company’s equity plan, grant agreements, and shareholder documents. In Washington, D.C., probate law determines who has the legal authority to act for the estate. Missing deadlines can cause heirs to lose their rights to exercise stock options or keep certain shares. Here’s a simple guide to help understand the process.
Deadlines for Exercising Stock Options
When the original owner of stock options passes away, their vested options can usually be exercised by the estate’s personal representative or a beneficiary. The time allowed to exercise these options depends on the company’s equity plan and the agreements made when the stock was granted. Some private companies only give heirs a short time, like 90 days or up to a year, to exercise the options. Others might let heirs exercise the options until the original expiration date, which is often 10 years after the grant date.
If the options are not exercised in time, they expire permanently and cannot be used again. To exercise the options, the heir must pay the “exercise price,” which is the price set when the stock was first granted. Exercising the options may also create taxable income, which is the difference between the exercise price and the stock’s current market value. The representative or beneficiary must follow the company’s procedures to complete the process and report the transaction for taxes.
Selling Shares After Exercising Options
When stock options are exercised, they turn into actual shares owned by the heir or estate. If the shares are from a public company, they can usually be sold through a brokerage account after being transferred to the heir. Selling public shares follows normal market rules.
Private company shares are trickier. These shares often come with restrictions, like needing company approval to sell them or only allowing sales to approved buyers or existing shareholders. Sometimes, heirs cannot sell the shares until a specific event happens, like the company giving approval or a future event like an acquisition or public offering.
Company Buyback Rules
Private companies often have buyback rules in their agreements. These rules let the company buy back shares from the estate or heir after the original owner’s death. The agreement will explain:
-
How much time the company has to buy back the shares
-
How the price for the shares will be decided (such as fair market value or another formula)
-
When the company must complete the payment
These buyback rules are legally binding. If the company chooses to buy back the shares, the heir or estate will get money instead of owning the shares. The value of the buyback depends on how the price is calculated in the agreement.
Waiting for Liquidity Events
Private company shares are not always easy to sell. Heirs might have to wait for a liquidity event, like a merger, acquisition, or the company going public, before they can sell the shares. Until then, they must follow all company rules about owning the shares, including any deadlines, transfer limits, or agreements with other shareholders.
When a liquidity event happens, heirs will receive their share of the money, just like other shareholders. However, the timing and value depend on the company’s agreements, such as vesting schedules or buyback rules. Until the shares can be sold, the heir or estate must handle tax filings and follow all the company’s requirements for owning or exercising the stock.
Plan Ahead for Equity That May Outlive You
Planning for what happens to company equity after someone passes away is very important. This includes equity tied to vesting schedules, stock options, and shareholder agreements. A legal representative will need the proper authority to act, meet deadlines for equity plans, and handle tax filings. Without clear instructions, important options could expire, shares might be bought back at bad terms, and beneficiaries could face long delays.
To avoid these problems, it’s important to have a clear estate plan. This plan should state who will inherit the equity, who can manage or use it, and how taxes or costs will be paid. Wills, trusts, beneficiary forms, and company agreements should all work together to make sure everything goes smoothly.
If you own stock options, vested equity, or founder shares, it’s a good idea to review how they fit into your estate plan. At Kevin C. Martin, Attorney at Law, PLLC, we help people and business owners make wills, trusts, and powers of attorney to handle complex assets like private company equity and rewards.
If you’d like to discuss how your estate plan addresses equity or stock options, reach out to us to schedule a private consultation and explore your legal options.
