patrick.net

Swebb,

AMT requires that the spread between the option and strike price from an ISO is counted as income for AMT purpose, which is 26 or 28 percent. For regular tax, there is no taxable event from the excercise. To the extent that your tax situation is AMT or the ISO spread puts you into AMT, it will be an issue. This is however a AMT credit so it may be offset in subsequent years if you are a regular AMT payer.

There are two traps:

Disqualifying dispositions - There is a possibility that the dispostion is non-qualified. so it's treated as an ISO for AMT purpose, but the disposition of it cause it to be an NSO anyway. In other words, it ends up as an NSO for regular tax and ISO for AMT tax. worst of both world.

Sales price lower than option price: Since the taxable event occurs when the stocks are disposed of, not excercised, you may end up below both the strike and option price. Even though there is no tax consequence from realizing gain on excercise date like NSO's, you still won't recover the tax consequence from AMT (to the extent that the AMT credit from this cannot be flipped quickly, which may not be possible. This is a bigger concern for NSO.

With Enron, the typical situation was employees excersised their NSO's and have pay the tax on oridinary gain. They let the equity ride to 0 and end up with capital loss attributes. There is no loss carryback for individuals and limited to 3K per household.

It costs the employer more to implement ISO's because the expense is non-tax deductable for them (unless it ends up as a disqual). NSO expense are fully deductable for the corporation.. From that perspective, if you are in a high tax bracket, take ISO's if the share offered are the same.

Thanks for the response. I am not a regular AMT payer, but it sounds like I need to read up on it to really understand what is going on.

The stock options would sit in the 28% tax bracket, but I'm not likely to be exercising and selling options periodically. It would more likely be on an acquisition event, which (if it happened) could push many (most?) of the options into the top bracket. I don't know how these things tend to play out, but my guess is that it would be exercise and sell back-to-back...negating the long term capital gains benefits.

Negotiating for more salary and fewer options may be possible, as well.

If you are getting restricted shares or if you are getting stock options that can be exercised before vesting, there is an additional thing to consider: How confident are you in the company and in the likelihood that you will stick around long enough for vesting? Look up 83(b) elections. Normally what happens with both restricted stock and stock options is that they are taxable when they vest.

If you are confident in both factors, you can instead, if you make a timely 83(b) election, pay regular income tax on the value of the options at receipt . Otherwise, you must pay regular income tax (including FICA) upon vesting.

This is a no-brainer if you get restricted founder's stock of a startup -- e.g. the company gives you 5,000,000 shares at $0.001/share. You pay taxes on $5K. If the company is ever worth anything (even $1/share), you saved yourself a ton on taxes (still would have to pay capital gains).

It's harder to decide if you are a run of the mill employee. I have a friend who chose not to do it for restricted stock that vested yearly over four years, and the stock went up 4X. He didn't make the election because he thought he wouldn't be there for 4 years, but he likes the job and stayed there for the whole period. The difference was significant enough, although paid yearly over 4 years instead of at the beginning. Still, it may have been a good hedge, since he wasn't sure if he'd stay for 4 years, and he didn't know that the stock price would rise that much.

For options, the calculation is also harder. You have to commit to exercising the option early, which has its own risks in some cases. If the stock goes to zero, you lose your whole stake (although you could deduct this as a capital loss).

swebb says

I am not a regular AMT payer, but it sounds like I need to read up on it to really understand what is going on.

Doesn't matter in all cases. An ISO can push you into the AMT.

Well, as usual, it's more complicated than I want it to be, and I'm going to have to dig in to make sense of it all. I have been at the company since the beginning (2006) and had a significant portion of ownership in the form of common stock (not options). The value of this stock, unfortunately, has been nearly wiped out in subsequent financing rounds. I'm not sure if I will stay long enough to fully vest my new options. Things have improved significantly lately, so I do think we, as a company, are on track to do well. However, since the stock I hold is common, I'm not very likely to do well from the stock holdings. As VC financing goes, there are a lot of people in line in front of me. I think I stand a much better chance of seeing an upside because I can continue to add value than because of the stock I hold.

Sometimes I want to just say "fuck it" and go live on a boat. What are the tax implications of that? :)

If you are an employee you'll most likely get non-qualifying stock options, companies do it as a tax write off.

Just make sure you get them at a low enough price where they can make money. I hear stories from people who got stock options which were worthless during vesting period since they got theirs at the bubble time.

swebb says

of the "incentive" flavor, or the "non-qulifying" flavor

If your a private company .. then ISO,
else a public company ... NonQualified.

Considering your later statement mentioned VCs. holding preferred meaning your private .. would make it ISO.

swebb says

Sometimes I want to just say "fuck it" and go live on a boat. What are the tax implications of that? :)

ISOs ?

http://en.wikipedia.org/wiki/Employee_stock_option
http://en.wikipedia.org/wiki/Incentive_stock_option

The tax benefit is that on exercise the individual does not have to pay ordinary income tax (nor employment taxes) on the difference between the exercise price and the fair market value of the shares issued (however, the holder may have to pay U.S. alternative minimum tax instead). Instead, if the shares are held for 1 year from the date of exercise and 2 years from the date of grant, then the profit (if any) made on sale of the shares is taxed as long-term capital gain. Long-term capital gain is taxed in the U.S. at lower rates than ordinary income.

FortWayne says

If you are an employee you'll most likely get non-qualifying stock options, companies do it as a tax write off.

NQ and ISO have a deferred compensation portion which is ordinary compensation expense over the life of the option. So no difference.

swebb says

I seem to remember that there were people who got totally screwed because they owed tax on options that were no longer valuable (Enron, maybe), but I haven't been able to find any references to this.

That would be NQ, the strike price was at peak prices, but the market prices were well below. Like Netflix, stock price well under 100, but strike was over 200. Or Google strike price at 600-700 as market prices tanked to under 300. Both were screwed.

FortWayne says

If you are an employee you'll most likely get non-qualifying stock options, companies do it as a tax write off

This is untrue, most gets ISO's. Companies grant stock option mostly
as a long term retention strategy and ISO's are better in that regard. Bonus' are one year deal, but options string the employees for four years to realize and only if the company does well. Most start-ups don't pay income tax in about their first 10 years of birth anyway so the ISO expense addback does not effect cash position.

FortWayne says

just make sure you get them at a low enough price where they can make money. I hear stories from people who got stock options which were worthless during vesting period since they got theirs at the bubble time.

Stock option plans are formal and filed and approved by the board of directors and reviewed and voted by shareholders. An employee will have no say on the option price as that is predetermined by the plan.

thomas.wong1986 says

NQ and ISO have a deferred compensation portion which is ordinary compensation expense over the life of the option. So no difference.

All stock options are governed by FAS123 and subsequently FAS123R which requires expense recognition in the financial statements or GAAP accounting. Fortwayne is still correct, ISO expense (based on whatever model used to expense options) are generally non-deductible for tax purposes to the corporation. The exception is when the employee has disqual disposition so the income burden shifts from the corporation to the employee

thomas.wong1986 says

That would be NQ, the strike price was at peak prices, but the market prices were well below. Like Netflix, stock price well under 100, but strike was over 200. Or Google strike price at 600-700 as market prices tanked to under 300. Both were screwed.

The taxable event occurs upon excercise. A rational employee will only excercise if there is a benefit and they are free to sell at that time and realize the gain. In the above scenerio, no-one would excercise their shares so there is no tax event. it's just worthless options. People with worthless options usually look for another job. Every now and then, the board of director may have to re-price the options lower for retention purpose.

swebb says

I have been at the company since the beginning (2006) and had a significant portion of ownership in the form of common stock (not options). The value of this stock, unfortunately, has been nearly wiped out in subsequent financing rounds.

Do you mean your portion of ownership has bee nearly wiped out by dilution in subsequent financing rounds? Generally speaking, each subsequent financing round should be at a higher valuation, so your total stock value should be going up.

thomas.wong1986 says

Or Google strike price at 600-700 as market prices tanked to under 300. Both were screwed.

theLandlord says

Every now and then, the board of director may have to re-price the options lower for retention purpose.

Google repriced to fix this problem.

All true what landlord stated.

corntrollio says

Do you mean your portion of ownership has bee nearly wiped out by dilution in subsequent financing rounds? Generally speaking, each subsequent financing round should be at a higher valuation, so your total stock value should be going up.

Lower valuations with subsequent financing rounds can happen. Reverse spits for private companies over the past 10 years has been common.

thomas.wong1986 says

Lower valuations with subsequent financing rounds can happen

Down rounds are not always a good sign...

thomas.wong1986 says

Reverse spits for private companies over the past 10 years has been common.

Reverse splits don't wipe out value.

Not every start up is gold and not every stock option is a winning number. Crap happens.

thomas.wong1986 says

Not every start up is gold and not every stock option is a winning number. Crap happens.

Golden words spoken there.