There are three kinds of taxes you should consider when you exercise your Incentive Stock Options the most common form of employee options : alternative minimum tax AMT , ordinary income tax and the much lower long-term capital gains tax.

Tax Rates Drive the Decision to Exercise

You are likely to incur an AMT if you exercise your options after their fair market value has risen above your exercise price, but you do not sell them. If you then hold your exercised options for at least one year before you sell them and two years after they were granted then you will pay a combined federal-plus-state-marginal-long-term-capital-gains-tax-rate of only The AMT you paid will be credited against the taxes you owe when you sell your exercised stock.

If we assume the same outcome as in the example above, but you wait to exercise until the day you sell i. You will owe no taxes at the time of exercise if you exercise your stock options when their fair market value is equal to their exercise price and you file a form 83 b election on time. Any future appreciation will be taxed at long-term capital gains rates if you hold your stock for more than one year post exercise and two years post date-of-grant before selling.

If you sell in less than one year then you will be taxed at ordinary income rates. The most important variables to consider in deciding when to exercise your stock option are taxes and the amount of money you are willing to put at risk. Most companies offer you the opportunity to exercise your stock options early i.

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If you decide to leave your company prior to being fully vested and you early-exercised all your options then your employer will buy back your unvested stock at your exercise price. The benefit to exercising your options early is that you start the clock on qualifying for long-term capital gains treatment earlier. Very early employees are typically issued stock options with an exercise price of pennies per share.

It could make a ton of sense to exercise all your shares before your employer does its first A appraisal if you can truly afford to lose this much money.

I always encourage early employees who exercise their stock immediately to plan on losing all the money they invested. In many cases that might not be until you really believe your company is ready to go public. Earlier in this post I explained that exercised shares qualify for the much lower long-term capital gains tax rate if they have been held for more than a year post-exercise and your options were granted more than two years prior to sale. To find the ideal time to exercise we need to work backwards from when your shares are likely to be liquid and valued at what you will find to be a fair price.

Employee shares are typically restricted from being sold for the first six months after a company has gone public. There is usually a period of three to four months from the time a company files its initial registration statement to go public with the SEC until its stock trades publicly. Therefore you will take the minimum liquidity risk i.

These characteristics included meeting their pre-IPO earnings guidance on their first two earnings calls, consistent revenue growth and expanding margins. Based on these findings, you should only exercise early if you are highly confident your employer can meet all three requirements. The higher your liquid net worth, the greater the timing risk you can take on when to exercise. In that case you can better afford to lose some money, so exercising a little earlier once you are convinced your company is going to be highly successful without the benefit of an IPO registration may make sense.

Exercising earlier likely means a lower AMT because the current market value of your stock will be lower.

Understanding Startup Stock Options

The difference between the AMT and long-term capital gains rates is not nearly as great as the difference between the long-term capital gains rate and the ordinary income tax rate. In contrast an average Wealthfront client typically pays a combined marginal state and federal ordinary income tax rate of Snowflake, Unity Technologies, and Asana recently went public. Airbnb plans to file its IPO later in If you want to get a head start, download my free guide, Preparing for an IPO. Grant : you were given stock options upon hire.

Perhaps you received additional grants upon promotion. Plan : the IPO process will be an emotional roller coaster. Having a plan will help you mitigate the emotions. Vest : how much time must elapse before you earn the right to exercise your options. Exercise : once your options are vested, you have the right to buy exercise your company stock at a fixed price exercise price, or strike price at any point before the grant expires.

Equity How stock options are taxed | Carta

Tax authorities consider the purchase price a. The first step is to see if you have enough cash to exercise the options. Calculate the intrinsic value by taking the current share price minus the exercise price. Some people forget to discount the intrinsic value of the stock option by the exercise price. If the stock price climbs over the years, the beauty of stock options is that you decide when to exercise the option e.

A financial planner with expertise in equity compensation planning can help you make the exercise decision in the context of your broader financial goals. At the very least, before you exercise options, I recommend that you work with a tax professional to run a tax projection.

Ordinary income tax vs. capital gains tax

And you can proactively offset the ordinary income from the exercise of NSOs with income deferral techniques such as increasing k contributions, or perhaps increasing charitable gifts. Check to see how many stock options are vested and therefore exercisable. If you exercise NSOs, your company must withhold taxes income tax federal, state and payroll taxes Medicare, Social Security, local taxes if applicable. Be sure to consult a tax professional to determine your total tax bill.

But you will need to do an AMT calculation on Form if you exercise ISOs and hold the resulting stock through the calendar year of exercise. When I help my clients invest in a diversified portfolio, I put them in a mix of stocks and bonds using low-cost mutual funds or exchange-traded funds ETFs that allow them to invest in thousands of stocks and bonds across the world US and non-US and across all segments of the economy healthcare, technology, manufacturers, etc.

An exception to selling the stocks right away is if you want to meet the special holding period rules for ISOs. As you go down the list of order types, there are more decisions that need to be made. After your company is listed on the stock exchange, you likely will not be able to exercise options or sell stocks right away. This is because a lock-up period may apply. This is a waiting period after the IPO that forbids company insiders from selling shares. The lock-up period typically lasts six months.

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Once the lock-up period ends, you may continue to face restrictions on selling company stock. This is to prevent insider trading, which is a violation of federal securities law. Your company will announce when trading windows open. In my next post , learn how stock options are taxed. Get answers to the top questions from Superstar Women during this unnerving time. Your stock options are complicated.