Stock Options Matt Grodin CPA

1 Definitions Incentive Stock Option (ISO)– Most tax advantaged option, but also the most complicated. You will likely pay Alternative Minimum Tax (AMT) on exercise, but you can get a credit for this if you hold long- term. Also – there’s no withholding. In the end, you can qualify for long term treatment on the exercise AND sale. Nonqualified Stock Option (NSO) – When you exercise, you purchase it cheaply, and the discount is treated like compensation income. Tax is withheld at 25% federal, and state withholding. Note – this may not be the actual tax due. You can then decide whether to hold the stock for long term treatment or not from the point of exercise. Restricted Stock Units (RSU) – Similar to NSO, but the stock vests, there is no need to purchase it at exercise

2 Incentive Stock Options GrantExerciseSell Price Date Grant: no tax effect Exercise: Potential AMT on price difference between FMV at exercise and exercise price. This AMT will be a credit in the (possibly distant) future. Sell: Regular tax purposes: Capital gain on difference between sale price and exercise price. If in AMT: capital gain on difference between sale price and FMV at exercise Long term rates IF exercise 1 year after grant and sell 2 years after grant Sell in same day/same year – on W-2 like comp, but no tax withheld. Potential strategy: Sell enough to cover AMT, hold on to rest for long term capital gains. Exercise early to lock in low cost basis. If basis isn’t low – hold onto the option to reduce risk. FMV Exercise price

3 NSO – Cashless exercise GrantExercise and Sell Price Date Grant: no tax effect Exercise and sell: : Receive your cash. Some of the cash will he held to pay for the purchase, and some (typically 25% Federal, 10% state) will be held for taxes – also showing up in your W2. Recognize ordinary income on the bargain difference between FMV and Exercise price. (It should show up in Your W2.) FMV Exercise Price Vesting

4 NSO Timing GrantExerciseSell Price Date Grant: no tax effect Exercise: Purchase the stock at a discounted price. Recognize ordinary income on the bargain difference between FMV and Exercise price. (It should show up in Your W2.) Sell: Capital gain (or loss) on difference between FMV and Purchase price Long term rates IF held for more than one year after exercise. Potential strategy: At exercise, immediately sell enough to come up with cash to purchase all of your options. If stock is not transferrable at the time of exercise, an 83(b) election will accelerate income recognition and start the clock on capital gains. Exercise early to lock in low cost basis. If basis isn’t low – hold onto the option to reduce risk. FMV Exercise Price Cost basis Vesting

5 RSU GrantSell Price Date Grant: no tax effect Vesting: Ordinary income in your W2 Tax withheld typically at 25% federal 10% state which may or may not be right Sell: Capital gain on difference between FMV and Purchase price FMV Cost basis Vesting

6 ISO going down? GrantExerciseSell Price Date Grant: no tax effect Exercise: Potential AMT on price difference between FMV at exercise and grant price. This AMT will be a credit in the (possibly distant) future. No special AMT consequence if sold in year of exercise Sell: Regular tax purposes: Capital loss on difference between sale price and exercise price AMT purposes: capital loss on difference between sale price and FMV at exercise Long term rates IF exercise 1 year after grant and sell 2 years after grant FMV Exercise price

7 83(b) Election – starting the clock If there are restrictions on stock when exercised, income will not be recognized until the restrictions are removed. An 83(b) election has several effects: Starts the clock on capital gains at the date of exercise even if restrictions are in place. Makes the stock holder recognize income at the date of exercise, potentially resulting in less income to recognize. Option holders may be able to exercise unvested stock. If this is the case, income will not be immediately recognized unless an 83(b) election is made.

8 When to Exercise and hold vs Same day sale ISO Exercise and Hold Your regular income tax rates are substantially higher than long term capital gain rates ( 33%+) 225k+ before options Exercise price is relatively low compared to FMV at date of exercise You are prepared for the AMT Same day sale Relatively low regular income tax rates. Need cash this year Reduce risk, diversify, opportunity cost