Author Topic: Exercising Stock Options- ISO  (Read 1063 times)

NorCal

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Exercising Stock Options- ISO
« on: June 02, 2018, 07:33:20 AM »
I just gave notice at my job, and I've decided I'm likely going to exercise my stock options (ISO) instead of letting them expire.  I figured I'd put it here in case there are contrary opinions.  Details:

1. We have a pre-existing well diversified portfolio.  Once exercised, these options will represent ~1.5% of our portfolio.

2.  The exercise price would be about $20K.  As of the last valuation, the shares would have a market value of about $25K.  This is private-company stock, so there is no secondary market for it.

3. This is a private company that is perpetually "almost" ready to go public.  I'm confident they will actually go public at some point, but I'm not convinced it's "right around the corner" as they've been claiming for the past few years.

4.  Despite their best efforts, the company is actually doing pretty well in 2018.  I expect the current value is actually higher than the valuation implies.  However, it also wouldn't surprise me if the company shoots itself in the foot with some type of scandal or boneheaded move.

5.  I would have to sell existing holdings to fund this purchase.  I routinely invest all excess cash pretty quickly.  I can sell specific holdings to avoid a tax hit, although this would throw off my allocations until I have more cash to invest.  This will stress me out more than it reasonably should (MPP, I know).


Financial.Velociraptor

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Re: Exercising Stock Options- ISO
« Reply #1 on: June 02, 2018, 08:04:12 AM »
At 1.5% of your portfolio, this is a reasonable risk to take if you know the company and its prospects well.  I had a professor in grad school who liked to say "Daddy always said" ("Daddy" was also a Ph.D. professor of Finance from west Texas). "You pays your money.  You takes your chances." 

Gratz on giving notice!  Are you retired or just upgrading your career?

MustacheAndaHalf

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Re: Exercising Stock Options- ISO
« Reply #2 on: June 02, 2018, 09:01:45 AM »
I could be wrong, but does buying options for $20k which are worth $25k incur a tax on the additional $5k amount?  Might be worth looking that up.

You could also stop reinvesting dividends in your accounts, and use the dividends to buy back the assets you sold to make this purchase.  That could speed things up, especially if you have quarterly dividends coming out this month.

I think it's important to exercise these options.  It's ~1.5% of your portfolio assets, and you avoid any regret at wondering what might have been.

NorCal

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Re: Exercising Stock Options- ISO
« Reply #3 on: June 02, 2018, 09:45:41 AM »
Gratz on giving notice!  Are you retired or just upgrading your career?

Thank you!  Part of our FI plan is to relocate from the Bay Area to a less expensive area.  My wife just accepted a job in Denver, and I'm taking a few months off to get the family settled.  We still have a few years to FI, but this will be a big step towards making it happen.

If you know anyone in Denver looking for some corporate finance help around September, let me know :-)


I could be wrong, but does buying options for $20k which are worth $25k incur a tax on the additional $5k amount?  Might be worth looking that up.


For ISO's, the $5K would be taxable when we sell the shares (since they're already vested).  I could technically exercise some additional unvested shares which would have different tax consequences. However, I'd rather not deal with the hassle for the amount of money involved.

Timmm

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Re: Exercising Stock Options- ISO
« Reply #4 on: June 02, 2018, 10:07:48 AM »
For ISO's, the $5K would be taxable when we sell the shares (since they're already vested).  I could technically exercise some additional unvested shares which would have different tax consequences. However, I'd rather not deal with the hassle for the amount of money involved.

I think the $5k paper gain would count as income for AMT tax calculation. If you're close to the AMT threshold, you may have immediate tax liability. I think AMT tax would be 28%, and how this reconciles with your future actual tax liability when you sell is complicated. I believe it is something like you are carrying an AMT credit forward and can apply that to your tax bill in future years where you DON'T owe AMT - you can take a credit up to the difference between your regular tax and hypothetical AMT tax due out of that credit.

If you're safely out of AMT range, I agree, there's no tax factor here. It does sound like a reasonable gamble given your other investments. And by separating from the company as an employee, you're still probably less dependent on their fortunes with this small investment. So a net reduction in risk/dependency on them, though not all the way to zero.

Welcome to Denver! We moved here from SoCal largely for cost of living expenses in the 90s and think it's still a good choice. We can visit California once or twice a year for a lot less than living there.

PaulMaxime

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Re: Exercising Stock Options- ISO
« Reply #5 on: June 02, 2018, 10:42:38 AM »
So that 5K would only be taxed if you hit AMT with the additional income.

Going forward you have two cost bases on the shares: AMT and non-AMT. This will come up when you sell the stock at some point in the future. You'll use the AMT basis (which is higher) when you calculate the AMT on your tax return and the regular basis in the normal calculation, and pay whichever is higher.

AMT on 5K isn't that much money and you get a higher cost basis anyway so it will sort of work out. with ISOs you do get to defer taxes on the difference between your strike price and the fair market value of the shares assuming you don't fall under AMT the year you exercise.

What I didn't realize when I exercised my shares was that the two bases exist on the stock no matter if you had AMT that year or not.


Financial.Velociraptor

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Re: Exercising Stock Options- ISO
« Reply #6 on: June 02, 2018, 03:44:34 PM »
Does AMT still exist?  I thought the latest tax bill basically killed it...

seattlecyclone

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Re: Exercising Stock Options- ISO
« Reply #7 on: June 02, 2018, 09:05:21 PM »
AMT still exists. The exemption phases out at a much higher income level so fewer people have to worry about it. Someone exercising a bunch of ISOs probably will have to pay some extra tax, but $5k isn't likely to push you over the top.

NorCal

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Re: Exercising Stock Options- ISO
« Reply #8 on: June 02, 2018, 09:37:18 PM »
Thanks for bringing up the AMT!  I had forgotten about that consideration.  Now I actually have to figure out the new tax law.

We've always been heavily hit by the AMT, however it was driven entirely by state income taxes as our only deduction.  Part of the fun of being a high income Californian.

Now that state income tax is effectively non-deductible, I'm assuming the AMT no longer applies to us, although I honestly haven't looked at the details. 

Either way, it won't materially change my math.  Either I pay tax now, or I pay it in the next few years.