ISO Options, company not public. What's my best course of action?

[kel]

Hey folks!

I've spent a LOT of time learning about options and AMT trying to figure out wtf I should do with mine.

Here's the basics:

Fully vested at EOY 2016.
5x difference between strike price and current value. DEFINITELY worth exercising them at some point (free money!) even if price dropped by half (it won't).
No current way to sell shares that I know of. Company buys back infrequently and has no schedule. IPO is not in next year or two's game plan. If they did a buyback, I could sell exercised or unexercised options back. After IPO stock value is likely to go up, but I can't be sure really.
Exercising the options would cost almost $50k, and taxes would be (I think?) another $60k O_O
(not sure if this is important, but ..) current income = ~$85k. Live in CA. Maxing all the retirement vehicles.

The pressure to do *something* comes from the fact that I have incredibly itchy feet. Even though my trajectory at this company is great and they want me to stick around, I am entertaining taking a break. If I do, I would have to exercise my options within 6 months of leaving. I will have enough taxable investments by then to cover exercise + taxes but that might be everything. I have no idea when I can even sell these shares back...

So what would you do? The best thing is obviously to tough it out. Golden handcuffs are real. Other things I could do - exercise them over a couple years, exercise them all at once by cashing out my taxables next year, wait and exercise them only if I am absolutely going to leave the company (risky if market is flopping at the time)

I'm stumped. 'Til then I'm working at making myself tolerate the situation.

[seattlecyclone]

I have been through this exact situation before. In my case, the company did well, had an IPO, and currently trades at more than 10x my strike price. I hope the same for your company, but you should not kid yourself about the possibility that the opposite will happen. This stuff is risky, but with great risk can come great reward.

Assuming the stock's fair market value (FMV) will only go up between now and the IPO, the best time to buy the shares is right now. The difference between your strike price and FMV counts as income for the AMT, so buy when the FMV is low to minimize your taxes in the short term. In the long term, you can actually get this AMT refunded to the extent that your AMT in future years is less than your regular tax. If you have never owed AMT before, you may be able to lower your tax burden by spreading your exercise events over two tax years, because you'll have some "wiggle room" where you could buy a few shares without owing any AMT at all, so being able to exercise a few shares AMT-free is a good idea if you can manage it. Balance this against the likelihood that the FMV will increase before January.

[kel]

Incredible advice, thank you so much. Any tips on how to know how much I can exercise before hitting AMT? I am going to try to calculate by hand but it's been a pain in the butt previously. The biggest thing holding me back is the opportunity cost of not having the money in the market or even having to cash out taxables to exercise, but I guess I shouldn't get torn up about it since it's a guaranteed x00% return at some point versus whatever the market is doing..

[seattlecyclone]

Incredible advice, thank you so much. Any tips on how to know how much I can exercise before hitting AMT?

Try the spreadsheet from excel1040.com. Start by entering your expected W-2 income, investment income, etc. to get a baseline estimate for what will happen if you exercise no ISO shares. Then go to the Form 6251 (AMT) tab and enter some numbers on the ISO exercise line to see how high you can get before you owe AMT. Remember that the amount you enter on this line would be the difference between the fair market value the company reports to the IRS and your strike price.

If anything this should slightly underestimate the amount you could exercise without owing AMT, because it's using last year's tax formulas. Many numbers (bracket cutoffs, phaseout amounts, etc.) have been increased slightly this year to account for inflation, and these should combine to make your real tax liability a bit lower than what last year's formulas will show.

[kel]

You da best.

[bacchi]

Filing 83(b) may be helpful.

[seattlecyclone]

Filing 83(b) may be helpful.

From what I have read, these 83(b) elections only apply to stock grants, not stock options.

[Cathy]

The general rule is that if property is transferred "in connection with the performance of services" then the value of the property is included in gross income "in the first taxable year in which the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture". 26 USC § 83(a).

An exception to the general rule is that a person receiving such property may instead elect to include its value in gross income "for the taxable year in which such property is transferred". 26 USC § 83(b)(1).

However, § 83 does not apply to "the transfer of an option without a readily ascertainable fair market value". 26 USC § 83(e)(3). That would appear to describe at least some options issued in respect in respect of private company stock. Indeed, in the case of startup companies, the whole theory behind equity-based compensation is that you don't know in advance whether your stock options are valuable or are worthless.