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Similar to the strategy discussed in the NQSO section, this strategy may appeal to those clients looking to limit their cash outlay or exposure to a concentrated position in company stock. The options are exercised and the shares are sold more than two years after the grant date and more than one year after exercise. The tax results of a qualifying disposition are described above.
As noted, in this scenario, appreciation in the value of the stock above the exercise price will be taxed at long - term capital gains rates. Intentional disqualifyingdisposition. Prior to the dot - com bubble of the late s, many individuals in the tech industry exercised highly valued ISOs, incurring a large AMT liability on top of the price paid to exercise options. After the market crash and subsequent rapid devaluation of their position, some were left holding stock worth significantly less than the price they paid to acquire it and were unable to pay the AMT incurred due to the exercise of the ISOs.
A method to potentially avoid a disaster like this would be to exercise early in the year, or some other time that is deemed advantageous, and track the stock value throughout the year. If the value greatly depreciates, the stock can be sold before year end. This would intentionally trigger a disqualifying disposition, thus avoiding the positive AMT adjustment and any accompanying AMT tax liability.
This is a mix of the exercise - and - sell and the exercise - and - hold strategies.
Like the strategy discussed in the NQSO planning section, this can be used to improve cash flow during the exercise event. The immediate sale of the shares to cover the AMT is a disqualifying disposition. The remaining shares received can be held for future appreciation and, if the holding period requirements are met, favorable qualifying disposition treatment. If an individual already owns shares of company stock and wants to limit the cash outlay on the exercise of ISOs, a swap could be of value.
The existing shares will be exchanged with the issuing company for the new ISO shares. It is important to note that the swap itself is tax - free , but not necessarily the exercise, as this could generate an AMT liability. Consideration should be given for special situations, such as if the shares being swapped in are ISO shares themselves. The company's stock plan must allow for swapping.
When taxpayers find themselves subject to the AMT as a result of the exercise of ISOs, all or part of the AMT paid will generate a credit to be used against regular tax in future years. Often, the principal event that will unlock use of this credit is when the ISO shares are ultimately sold.
The regular tax stock basis is lower due to the absence of any income inclusion at exercise. This difference in basis for regular tax versus AMT purposes generally causes the regular - tax income to be higher than AMTI as a result of the sale. While paying AMT upfront may appear to be a loss, in many cases it will be a "timing" issue that balances out in the future. At times for CPAs, it is easy to focus narrowly on obtaining the best tax result possible.
It is important to take a step back and remember that the most favorable tax result is not always the best overall financial result for the client. Any stock option planning should be done as part of a comprehensive financial plan. It is crucial for CPAs to be proactive in gathering information from clients to provide timely and prudent advice.
Whether it is a routine situation, or something more nuanced, such as planning ahead of a possible merger or acquisition, the goal should be to maximize the value that clients receive from their option exercise and sale events. The various strategies discussed in this column represent many viable options to tackle a wide array of interpretations of the word "value. COVID upended tax season. Read the results of our annual tax software survey. This article discusses some procedural and administrative quirks that have emerged with the new tax legislative, regulatory, and procedural guidance related to COVID Toggle search Toggle navigation.
Stock option planning: Generating value By Joseph H. Editor: Theodore J. Nonqualified stock options NQSOs are the right to purchase shares of stock at a specified exercise price within a certain period.
Los Angeles. Report this amount on Form , line 2i. The Net Investment Income Tax is an additional 3. Measure ad performance. Your Money.
The following are some common courses of action associated with NQSO planning: Exercise and sell For risk - averse clients who want to minimize exposure to a concentrated position, or who simply do not wish to tie up substantial amounts of cash, exercising their options and immediately selling the underlying shares may be a viable strategy.
Exercise and hold Some clients have a higher tolerance for concentrated positions and will want to hold the stock to capture appreciation in the company's value. Incentive stock options ISOs are similar to NQSOs in that they represent a right to purchase shares at a specific price within a certain period. The following list illustrates some of the requirements that must be met for an option to be an ISO: The options must be granted pursuant to a shareholder-approved plan.
The grants must occur within 10 years of the date on which the plan was adopted or approved by shareholders, whichever is earlier. Additionally, the options may not be exercisable after the expiration of 10 years from the date of grant. To be a qualifying disposition for ISO purposes: The disposition sale of the ISO stock must take place more than two years after the grant date and more than one year after the exercise date. At all times during the period beginning on the date of the granting of the option and ending on the day three months before the date of exercise, the individual exercising the ISO was an employee of either the corporation granting the option; a parent or subsidiary corporation of the corporation; or a corporation, or its parent or subsidiary, that has issued or assumed a stock option in a Sec.
ISO tax treatment Qualifying disposition: If options that meet the requirements to be ISOs are disposed of in a qualifying disposition, the owner of the ISOs will receive the following tax treatment upon exercise of the options and the subsequent sale of the stock: Upon exercise of the ISO, there is no event for regular tax. This window, called a post-termination exercise PTE period , is usually around 90 days.
As you can see in the graph above, the benefit of doing this is that you are minimizing the pre-exercise gain. This could potentially limit your exposure to AMT. The downside here that you are taking on risk. There is no guarantee that your stock will ever be liquid, so you are paying to buy stock that could one day be worthless.
If you choose to exercise options early, you must file an 83 b election to take advantage of the beneficial tax treatment.
You only have 30 days to file this with the IRS, and there are no exceptions. The third common time to exercise your stock options is upon an exit, such as an IPO or acquisition. This is the least risky time to exercise because you know the stock is liquid. You can turn around and sell the stock for a gain hopefully the same day you pay to buy it. The downside in this situation is that you usually end up paying more taxes.
Remember: If you want to qualify for favorable tax treatment, you need to hold your ISOs for at least one year after exercising.
If this happens, your options will be treated like NSOs, and any spread between your strike price and the stock price when you exercise is taxed as ordinary income. Equity part 1 : Startup employee stock options. Equity part 2 : Stock option strike prices. Carta employee resource center.
How to value your equity offer free startup equity calculator. Employee Shareholder Bill of Rights. What does exercising stock options mean? What happens to equity when a company is acquired? This publication is not a substitute for such professional advice or services nor should it be used as a basis for any decision or action that may affect your business or interests.
Before making any decision or taking any action that may affect your business or interests, you should consult a qualified professional advisor. This communication is not intended as a recommendation, offer or solicitation for the purchase or sale of any security.
Carta does not assume any liability for reliance on the information provided herein. To do this calculation well, it may take the resources of a good accountant or financial advisor. When considering you could pay far less in tax by getting these complicated decisions correct, it may be well worth hiring a professional to help you.
You may also need to deal with the net investment income tax NIIT. And while not exactly a direct tax in the same sense as long-term capital gains and net investment income tax, you should still pay attention to how AMT is calculated and how it impacts how much tax you pay. You may face many different types of taxes owed when you have incentive stock options.
The timing of your exercise, hold, and final sale of the stock options can only further intensify the difficulty in understanding which of those taxes apply and what moves to make to reduce your bill. If you find yourself with incentive stock options, begin learning about the tax you may pay and when.
If you are not prepared to handle that on your own, it may make sense to work with someone who is an expert in tax and other financial planning needs that can arise. Knowing the rules and planning a good exercise strategy for your incentive stock options can lead to a material difference in the amount you receive in the end. None of the information in this document should be considered as tax advice. You should consult your tax advisor for information concerning your individual situation.
Your employer is not required to withhold income. Taxation of ISOs. ISOs are eligible to receive more favorable tax treatment than any other type of employee stock purchase plan. This treatment is what sets these.