Your client doesn't need to be a CEO to have millions socked away in a stock option plan.

The burgeoning number of stock option plans and the breadth of employees taking advantage of them are astonishing, says Tom Keating, marketing specialist at PaineWebber's corporate stock benefit services department in Weehawken, N.J.

Among 350 large companies, nearly 40 percent now offer stock option plans to their employees, up from 17 percent seven years ago, according to compensation consultant William M. Mercer Inc. The study only includes companies with plans covering at least half of their employees.

Indeed, stock option plans are moving down the corporate ladder. In a January study of 1,300 companies, the average lowest salary for employees eligible to receive options in 1999 was 58,100 dollars, according to compensation consultant Watson Wyatt.

When the statistics combine with the explosive growth of the stock market, a new type of client with unique needs emerges.

"It's not unusual to see an engineer or salesperson with over 1 million dollars in stock options," says Kaye Thomas, a tax attorney and head of Fairmark Press, a tax guide publishing company in Lisle, Ill. "I've seen people who make 80,000 dollars a year who have 3 million dollars worth of stock options. These are people with very little sophistication about stock."

Yet it takes sophistication about both the market and taxation to make the most of stock options.

A Plan's Basic Parts In a stock option plan, a company agrees to sell an employee a certain number of shares of company stock at a certain price within a specified time. The employee exercises the options by buying the stock at a below-market, or strike, price. The profit, or spread, is the difference between the value of the shares on the date of exercise and the strike price.

An option agreement spells out how and when options can be exercised. Typically the exercise price is set at or near the value of the stock when the options are granted. The options are often exercisable in stages and expire after 10 years. Some plans allow exercise after employment terminates. Some companies will loan the money to exercise options or allow cashless exercise. With cashless exercise, the employee can borrow the money from a brokerage firm to exercise the options, then sell the stock immediately, using part of the proceeds to repay the loan.

The option agreement also details the type of options granted. Most executives hold a mix of incentive stock options (ISOs) and nonqualified stock options (NQSOs) in their plans, says Howard Golden, a consultant with William M. Mercer in New York. Companies have annual limits on the value of shares they can make exercisable to an employee through ISOs, he says, so they need to mix in NQSOs to create an attractive options package.

NQSOs have no tax advantages. Employees report compensation income when they exercise. Profit from the sale of shares is also treated as compensation.

ISOs carry tax benefits--and tax traps. Employees don't have to report income when they exercise unless they sell shares at the same time. When they sell, they're taxed at the long-term capital gains rate, but only if they pay attention to holding restrictions.

Shares must be held two years after the company grants the options and more than one year after exercise. Ignorance of holding restrictions is "one of the bigger problems" ISO holders have, Golden says. "They know there's no tax at exercise, but they don't hold long enough and end up with a tax liability they didn't expect."

Brokers as Vital Links The confusion surrounding stock options is a good opportunity for brokers to make themselves indispensable. "We see a lot of first-time optionees who don't have a good overall picture of what they've fallen into," Keating says. "They'll get a 10-year option and think they should exercise it right away, take the money and run. It's their company's job to educate them, but that's not always happening. If their brokers can step in,it creates an opportunity to bond with clients."

A wirehouse broker on the West Coast has spent more than a decade working with stock option holders at one Fortune 500 company. His main job, he says, is "protecting people from themselves."

After handling about 4,000 exercises, the broker says the most common mistake people make is moving too quickly or too slowly to exercise options. "They'll want to exercise with just a teeny bit of equity, or they'll need 100,000 dollars for a down payment on a house and risk the stock price declining while they try to eke out a higher price," he says.

Another frequent mistake the wirehouse rep sees is people trying to time the market. They want to sell their company stock to reinvest elsewhere but wait around for a quarter-point more in the company stock price while the stock they want to buy takes off.

David Riccio, a Prudential Securities rep in New Haven, Conn., works with biotechnology executives new to ISOs. He's used to getting calls from clients wanting to exercise options immediately. "They have no idea what they want to do with the money, but they've seen the asset become significant and want to draw some off," Riccio says. That's when he introduces them to his process.

First, Riccio gets on the phone to the company and gets a clear picture of the option agreement. Next, he determines how much net worth is in ISOs. Then, he helps the client understand the trading patterns of the stock. "Since we have a lot of start-ups in the area, the stocks are quite volatile," Riccio says. "I usually show them why now wouldn't be a good time to exercise, establish a price range to aim for and tell them I'll call when we hit that range."

Exercising at the wrong price can trigger a tax problem (see "Five Tax Traps," Page 74). "I may urge them to exercise outside of that range if they have a large options holding to reduce their vulnerability to large price drops," Riccio says. He then sets long-term goals for the client's money after exercise and meets with the client's CPA to factor in the tax implications.

Brokers agree they are a vital link between their clients and CPAs. "Without getting a CPA involved, you can really screw up," says Bob Greenberg, an 18-year veteran with Financial Network Investment Corp. in Costa Mesa, Calif. "You can trigger AMT [alternative minimum tax] and your client can end up paying tax no one knew about."

Analysis and planning are what brokers bring to the table. The West Coast broker says he provides three services to ISO holders that his competitors don't: option portfolio analysis, exercise planning and a detailed tax report on each exercise.

"I help clients understand how to leverage their options," he says. "I can say, 'Here's your current equity in stock options. If the stock goes up 10 percent, your equity will go up 22 percent, and here's the dollar amount. I can break that down for each option they hold."

Taxation of stock options is undeniably complicated. Every time an option is exercised, the employee must report an adjustment for alternative minimum tax (AMT) purposes. The adjustment is equal to the difference between the exercise and the strike prices. However, a number of factors determine whether the person will end up paying the AMT.

Kaye Thomas, a tax attorney and author of "Consider Your Options," recommends you share these stock option tax traps with your clients.

Trap 1: Don't ignore your options while your company's stock goes through the roof. The AMT adjustment you must report might push you into having to pay AMT. The tax bite could be even higher than the maximum 28 percent for AMT, Thomas says, because of how various features of the AMT interact. Consider exercising a small amount near the end of each year, which will result in an adjustment too small to trigger AMT the following year.

Trap 2: If you plan to hold the stock, try to avoid exercising late in the year. Instead, exercise within the first three months of the year. Since the AMT isn't due until the following year, you can satisfy the long-term holding period before you have to pay the tax. You also get the chance to avoid AMT altogether if the stock declines and you sell before the end of the year.

Trap 3: Don't make certain kinds of stock transfers after exercise. You'll have to report compensation income if you make a gift of stock option shares to someone other than your spouse, use shares to exercise other incentive stock options or transfer the shares to an irrevocable trust.

Trap 4: Be careful about doing a cashless exercise. Remember that your profit from the sale will be taxed as compensation income.

Trap 5: Don't wait until after an IPO to exercise. Your company's pre-IPO stock might be valued at 3 dollars and the option agreement allows exercise at 1 dollar, Thomas says. When the IPO occurs, the stock may go to 20 dollars, then 60 dollars very quickly, with you left holding the options. Exercise then and face a big tax burden.

When you work for a company whose stock has been soaring for years, it's tough to make wise decisions about your stock option plan. That's the situation many Amgen employees face.

Richard Moran, a rep with Financial Network Investment Corp. in Gardena, Calif., has made a business out of helping Amgen employees who have well over half their net worths tied up in company stock.

Bringing his clients' expectations of their stock's growth down to earth is job No. 1.

"You must have a reasonable basis for a three- to five-year stock price estimate before you can plan option exercises," Moran says. He gets estimates from the company itself, ValueLine and the stock index the company is part of.

"Amgen tells option holders to expect 100 dollars a share to 125 dollars a share in two years," Moran says. "ValueLine expects modest growth. We can then run three simulations for the client to educate them on the range of variability the stock might experience. Next, we get the client to agree on which valuation model to use."

Integrating the money the client realizes from stock options with other financial planning efforts is the most important part of option exercise planning, Moran says. He first creates a general cash flow model of how the client's other investments will look over time. Next, he explores how holding different percentages of company stock in the portfolio will impact the future.

Moran then draws up an exercise schedule. For example, a client may have four blocks of stock options exercisable one year apart, he says. The valuation model selected shows that if the stock is 66 dollars a share today, he could target an exercise at 72 dollars a year later, another at 82 dollars the next year and another at 88 dollars the following year. Moran determines how much net cash the client will get for the stock options portfolio and shows how the net cash flow will affect the client's future goals.

Sometimes price doesn't matter. "One of my clients has 90 percent of his liquid net worth in Amgen stock or options," Moran says. In this case, the client could afford instead to exercise options at the earliest possible date, hold just long enough to get a long-term captial gain, then sell. The tax bite may be larger than if the client waited, but the risk of being overexposed to Amgen was worse, in Moran's estimation.

The growth of stock option plans is getting the attention of legislators. Rep. John Boehner, R-Ohio, has introduced a bill to encourage broader use of stock option plans (H.R. 3462). It would create a new hybrid of incentive and nonqualified stock options.

Like incentive options, the new option would allow employees to defer taxation on stock options until shares are sold, then be taxed at a capital gains rate, after a holding period. Like nonqualified options, the new option would allow companies to deduct the value of stock options granted to employees upon the employee's exercise. The bill would require employers to make the new stock option plans available to at least half of their employees.

At press time, the Boehner bill was scheduled for a bipartisan hearing in March.