Author Topic: Incentive Stock Options and retirememt  (Read 386 times)

JohnGalt

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Incentive Stock Options and retirememt
« on: February 25, 2017, 07:07:06 AM »
My privately held employer recently filed with the SEC and we are approaching an IPO.

I don't know the starting price and even then I have a 6 month lock out period so there are plenty of unknowns but I'm expecting to net a healthy 6 figure amount.  I've read through the couple past threads here where others have asked about this kind of thing. I've also read a fair amount about ISOs and taxation but nothing seems to address it from a RE perspective.  I'll be talking to a CPA once I get a feel for the IPO price but am wondering if anyone else here has gone through something similar.

This is pretty much all I was waiting for to pull the plug, which means I will likely have a much lower income next year (or possibly 2019 if I decide to stick it out for some additional vesting).  Has anyone strategically waited to cash out options until they are in a post earned income period to help reduce taxes?  My FIRE spending will put me in a near 0 tax situation so it feels like there should be some significant advantages to waiting but I'm also not sure how the AMT plays into things.

SeattleCPA

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Re: Incentive Stock Options and retirememt
« Reply #1 on: February 25, 2017, 07:49:04 AM »
I would recommend you read (and then maybe re-read) this book:

http://fairmark.com/books-fairmark-press/consider-your-options/

Pay particular attention to Thomas' discussions of when AMT hits (which is when you exercise) and then how to balance your risk and then the taxes (including the mechanics of the AMT credit).
« Last Edit: February 25, 2017, 07:50:44 AM by SeattleCPA »

vdub6127

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Re: Incentive Stock Options and retirememt
« Reply #2 on: February 25, 2017, 01:05:51 PM »
Congrats! Having worked at a company that went public about 6 years ago, I've been through quite a lot of ISO stock events. I can offer some perspective on it.

First, keep in mind that if you leave your company, you must exercise your options or they will disappear. Usually within 30-60 days. So you probably wont really be able to defer the tax hit from your last W-2 year. Perhaps you could get around this if you left in a December, I suppose... but even still I'd read up on the rules around that.

While ISOs are generally tax favorable (taxed on sale vs. taxed on exercise), if you exercise and hold the stock to try to lock in long term capital gains, you WILL be hit with AMT for that year, which will be sizable (for me, it was tens of thousands).

Another thing to consider is that the stock may not retain its value or even go up. I tried exercise and hold on the first year and got hit with a lot of AMT, and the stock didn't go up. Darn. Some folks will exercise near the beginning of the year, and make a decision on how much to unload at the end of the year to offset AMT. But you're probably subject to lock up periods and there's not a lot of flexibility on when you can sell, so that doesn't always work out.

The strategy I ultimately decided on is "same-day exercise and sale" in as much tax liability that you're willing absorb throughout the year for equal dollar increments at each available trading window. Holding is essentially timing the market, something I imagine most FI types would turn their nose up at. It's easy to get personally invested in the success your employer and not make the kind of dispassionate clinical decisions that ultimately would be the more beneficial ones.

The advice I kept hearing was: think of it as a cash bonus. If you got all that money in cash, would you immediately turn around and buy up your company's stock? Probably not. I'm willing to bet you'd throw it all in Vanguard or similar. Yes you will see some large tax bills, but hey, those are the rules. It's still free money.

One thing I didn't expect about ISO sales, at least in my case, is that they get reported as W2 compensation, not capital gains... if you hold for less than a year. So offsetting those sales with, say, some harvested tax losses doesn't work.

Being a part of a newly publicly traded company is really an emotional roller coaster ride. You'll find yourself obsessing and puzzling over market fluctuations. That being said, peace of mind has a lot of value. I never regret the stock I sold. I often regret the stock I held.

seattlecyclone

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Re: Incentive Stock Options and retirememt
« Reply #3 on: February 25, 2017, 02:12:39 PM »
I went through an IPO with ISOs a few years back.

For the AMT, you're taxed in the year of exercise on the difference between the fair market value of the shares and your actual strike price. Prior to IPO this value is typically determined by the company. In my case, the reported value just before the initial SEC filing was about half of the reported value just after the initial SEC filing, which was in turn about half of the IPO price, which was in turn lower than the closing price on the first day of trading. Every IPO is different, but if you think yours may follow a similar trajectory it may be to your advantage to exercise ASAP to minimize the reported AMT income. I know my coworkers who waited until after the IPO to exercise were kicking themselves for doing so. They didn't even know you could exercise earlier.

Exercising also starts the clock on long-term gains taxation. You have a six-month lockup after IPO anyway, so if you can cut the time interval between when you can sell and when long-term gains kick in down to just a few months, you may decide that the risk of waiting a bit to sell in exchange for a better tax treatment is worthwhile.
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Lea

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Re: Incentive Stock Options and retirememt
« Reply #4 on: April 20, 2017, 02:31:53 PM »
Exercising also starts the clock on long-term gains taxation. You have a six-month lockup after IPO anyway, so if you can cut the time interval between when you can sell and when long-term gains kick in down to just a few months, you may decide that the risk of waiting a bit to sell in exchange for a better tax treatment is worthwhile.

An IPO doesn't restart the clock for capital gains, does it? Ie, the purchase date is the date you exercised your options, not the date of the IPO?

bacchi

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Re: Incentive Stock Options and retirememt
« Reply #5 on: April 20, 2017, 04:47:54 PM »
This may be useful.

https://accountalent.com/83b-elections-for-dummies/

While exercising early and filing an 83-b doesn't avoid the holding period for qualifying sales, it may be used to reduce AMT. See Form 6251 instructions, right column of page 3:

https://www.irs.gov/pub/irs-pdf/i6251.pdf

If you're looking at a decent amount, it's probably a good idea to talk with a CPA that knows how to deal with ISOs.

seattlecyclone

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Re: Incentive Stock Options and retirememt
« Reply #6 on: April 21, 2017, 12:08:45 PM »
Exercising also starts the clock on long-term gains taxation. You have a six-month lockup after IPO anyway, so if you can cut the time interval between when you can sell and when long-term gains kick in down to just a few months, you may decide that the risk of waiting a bit to sell in exchange for a better tax treatment is worthwhile.

An IPO doesn't restart the clock for capital gains, does it? Ie, the purchase date is the date you exercised your options, not the date of the IPO?

Correct.
I made a blog! https://seattlecyclone.com/

The Roth IRA was named after William Roth, who represented Delaware in the US senate from 1971-2001. "Roth" is a name, not an acronym. There's no need to capitalize the final three letters.