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Ask HN: What are the tax implications of exercising startup options?

• thrawoway 11y ago
  Also, please add more questions if you have them. I'm sure I didn't ask all the pertinent ones, and if there's any place to find people who can answer, it's probably HN.
  • mtmail 11y ago
    I'm glad you ask questions. I've worked with many people who didn't understand the contracts they signed. Or thought they "owned" options (if the company fires you you generally loose the options).
• calcsam 11y ago
  Would I be paying tax as if I'd made capital gains in the amount of the delta between the strike price and the stock's value today? >> Yes, assuming you have not early exercised. This sucks. Would the stock's value today be based on the company's valuation at the most recent round of funding? >> Yes, the 409A valuation, which is generally ~30% of the valuation you hear about on TechCrunch for Series B-C companies. Investors received preferred stock. You have common stock. If the company goes on to raise more VC funding, would I be liable in future years for the 'capital gains' on this stock? >> Only when you sell it. Same as public stocks -- if you buy Twitter stock, and sell it in 5 years after it's gone up 2x, you have to pay cap gains only once after you sell. If the company went on to fail, would I be entitled to tax breaks for loss of stock? >> Not sure. The rules around this are pretty complex. Ask a lawyer.
  • awwstn 11y ago
    Would I be paying tax as if I'd made capital gains in the amount of the delta between the strike price and the stock's value today? >> Yes, assuming you have not early exercised. This sucks. >>>> So, if the company hasn't raised funding since I was offered my options, would I have zero tax liability for exercising my vested options?
    • x0x0 11y ago
      No, the board can still increase the fmv value for two reasons: 1 - the company has executed well and increased their value; 2 - to ratchet golden handcuffs tighter
• mtmail 11y ago
  Are you a founder with actual stock, or an employee with stock options? I assume employee here. As an employee if the company value is below the strike price you wouldn't exercise your options because it leads to a loss. Exercising options is voluntary. If you use the options to buy stock and hold it then profits and loss are subject to capital gains tax. Not sure what the minimum holding timeframe is in the US. In my experience most employees don't have the amount of money to buy the stock for long-term investment. To my best knowledge, losses are tax-deductable. Remember even if you own stock there is hardly an open market to sell like there is with publicly traded companies. As an employee if you exercise the options and you make a profit then the HR/payroll/accounting department will add that as income to the W2 and transfer the money minus income tax to your account. When you do your taxes you fill in the various fields of the W2 into your tax software. That's the best case and usually just takes you a couple of signatures.
• BjoernKW 11y ago
  Pretty much depends on the country where you file your taxes. In general, you pay taxes on the difference between the nominal value (strike price) and the current market price of the shares because that's the compensation you received instead of an ordinary salary. What happens afterwards depends on both if you sell the resulting shares at a profit or at a loss and when you sell them. Typically, taxation amounts to a lot less if you hold the shares for more than a year. See https://turbotax.intuit.com/tax-tools/tax-tips/Investments-and-Taxes/Non-Qualified-Stock-Options/INF12046.html https://turbotax.intuit.com/tax-tools/tax-tips/Investments-a... for more information on how this is dealt with in the US (including which tax forms to file).
  • kemitche 11y ago
    I am not an expert. That said, based on that article, there appears to be a difference between Incentive Stock Options (ISOs) and Non-Qualified Stock Options. You linked to information on that latter. Here is information on ISOs from Intuit: https://turbotax.intuit.com/tax-tools/tax-tips/Investments-and-Taxes/Incentive-Stock-Options/INF12049.html https://turbotax.intuit.com/tax-tools/tax-tips/Investments-a... At a glance, ISOs appear to be more favorable, tax-wise, in the US - they trigger AMT but not "direct" income tax.
• thrawoway 11y ago
  Here's another one: When should/shouldn't you exercise options when leaving a startup? Obviously, if you're leaving Uber you'd be wise to buy your vested equity if you can. Obviously, if you're leaving a company that is crumbling, you probably shouldn't. But what about an earlier, Series A/B startup that's promising but still shows a lot of risk? Or what about a later stage startup that is doing well but not on a guaranteed path to a huge exit? On what information would you decide whether or not to exercise?
  • imh 11y ago
    At the same time, if I was an early Uber employee and the difference between current value and exercise price is in the millions of dollars, then I'm on the hook for a tax bill I can't afford. Are there any solutions beyond taking out loans to pay my taxes?
    • sv123 11y ago
      Services like EquityZen can help find buyers for your common shares to offset the tax liability.
    • stevewepay 11y ago
      If you were an early employee and the difference is millions of dollars, I would suggest you stay at Uber until you can sell your shares. It's worth it at this point, and you getting a loan to exercise the shares represents a crazy risk.
    • refurb 11y ago
      Don't you have the option of sell to cover? You basically exercise all of the options, then sell a proportion to cover the taxes?
      • gknoy 11y ago
        I was going to say the same thing -- but if your company is not yet public, that might not be easy to do.
      • 11y ago
• yanda 11y ago
  1. The day you exercise, the IRS will tax you income tax on the value between the stock's current value and your strike price. This is true even though you haven't made money from selling the stock yet. 2. If the company is still private, the stock's value is determined by the last 409(A) valuation for Common stock that the company performed, assuming that your options are for Common stock (which is very likely). The company must perform one of these valuations a year and should provide you with that amount upon your request. 3. Exercising the stock starts the clock for long term capital gains treatement. That is, if you sell the stock a year after exercising it, you will pay capital gains tax on the value difference between the sell price and the value at exercise. Math wise: * TP = strike price (the price in your option contract at which you buy the shares) * EV = value of a share at exercise time, as determined by the latest 409A valuation * SP = sale price of a share when you sell the stock eventually * #S = the number of shares you have * IT% = Your income tax rate * CT% = Your long term capital gains rate At exercise: - You pay to exercise the shares: #S * TP - You owe in taxes: #S * (EV - TP) * IT% At sale - You make: #S * (SP - TP) - You owe in taxes, assuming you waited a year to sell: #S * (SP - EV) * CT%
  • kelukelugames 11y ago
    I have a nominal amount of options from the job I just left. The amount of money doesn't sound like it's worth the hassle. Maybe I should just let it expire.
    • jessedhillon 11y ago
      If you were granted ISOs (you were an employee and it is still within 90 days from your departure) and they are still available to you as such, exercise them as long as you're comfortable with the risk. Despite the parent comment, unrealized earnings on the exercise of ISOs are not taxed as income.
      • sv123 11y ago
        They are not taxed as income but are subject to AMT, so can absolutely leave you with a large tax burden if you aren't cautious. https://www.nceo.org/articles/stock-options-alternative-minimum-tax-amt https://www.nceo.org/articles/stock-options-alternative-mini...
• jkarneges 11y ago
  You pay the strike price, and you pay taxes on the difference between the current stock value and the strike price. For example, if the shares would have been worth $1,000 when you joined the company, then the strike price for the options is $1,000. If those shares would be worth $10,000 at the time you exercise, then you pay $1,000 to the company to receive the stock, and then you pay taxes on $9,000 (the difference) to the government. So you might be looking at like 3K in taxes in that case. You owe the taxes for the current tax year. You owe the taxes regardless of whether or not the company succeeds. Company could fold right after you exercise and you'd still owe Uncle Sam 3 grand. (Then there are also capital gains taxes to worry about after this. I am only describing your immediate tax burden.)
  • chwahoo 11y ago
    if the company tanks right after you exercise, can't you deduct the losses?
    • stevewepay 11y ago
      This happened to a lot of people in the Valley after the dot com bust. They exercised their options, triggering a tax liability, and then the shares tanked, leaving them with no money to pay off the liability. They could only deduct $3000/year. Lots of people were in a lot of trouble, but I remember hearing that finally the IRS made a change so that this wouldn't affect you anymore.
    • jkarneges 11y ago
      You should be able to deduct the loss, but I'm not sure how that plays with the tax owed, since the loss is a capital loss and you're paying tax on an object of specific value (not a capital gain). It might not simply cancel out.
  • Sikul 11y ago
    I was under the impression you only pay taxes if you trigger the AMT. If you do not trigger the AMT then you will just pay your ordinary income taxes on salary. Is that not the case?
• hberg 11y ago
  Let me answer a question you haven't asked but that is very relevant: Q: How can I mitigate the risk of holding startup shares that are illiquid and whose value can drop to zero? A: There are investment firms that will help you buy employee stock options and then split the proceeds with you. One of these is ESO Fund (esofund.com) and they are very nice people. They can help answer your other questions as well.
• erichurkman 11y ago
  Also, if you early exercise your shares, do not forget to file an 83(b) election within 30 days of your exercise. This also applies if you end up founding a company or are issued restricted stock awards.
  • chetanahuja 11y ago
    Surpiringly just one mention of the 83(b) process in this fairly well populated thread. Here's a good explanation of why you must know this to avoid a huge tax bill in case of your stock options becoming valuable some day. https://www.cooleygo.com/what-is-a-section-83b-election/ https://www.cooleygo.com/what-is-a-section-83b-election/
  • kevinpet 11y ago
    If I understand the question correctly, and it's about what to do when leaving the company, 83(b) is unnecessary. An 83(b) election says that you are choosing to recognize paper gains today that the IRS would normally require you to recognize when they are no longer subject to a substantial risk of forfeiture. If he's leaving, he must be exercising vested options, so there is no risk of forfeiture, so no need for 83(b). An 83(b) election is critical for unvested stock, i.e. "early exercise".
• GFK_of_xmaspast 11y ago
  Go ask a professional instead of an internet chat forum.
  • thrawoway 11y ago
    I'm well aware that I should take internet forum advice with a grain of salt. But, I thoght that sparking a discussion about the complexities and circumstances in an internet forum that has a very wide, deep pool of experience in this area might shed light on some interesting things. So far, it has.
  • andreasklinger 11y ago
    It's hard to find professionals who have better knowledge than the MAX() of the people reading this thread. Imo it's even hard (and costly) to find professionals who have enough exp in general.
    • hamburglar 11y ago
      Agreed. I had an options exercise in the hundreds of thousands once and my tax accountant, who came highly recommended but had relatively little experience with options, completely screwed it up until I caught it. I got a new accountant.
• medmunds 11y ago
  I really recommend _Consider Your Options_ as a great source of clear info for employees receiving any sort of equity compensation. One of my managers introduced me to it about 20 years ago. Pleased to see they've been updating it regularly since then. http://fairmark.com/books-fairmark-press/consider-your-options/ http://fairmark.com/books-fairmark-press/consider-your-optio...
  • Matt_Cutts 11y ago
    I stopped by to recommend this book too.
• andreasklinger 11y ago
  Q: What are the downsides to Coinbase's approach?
• philip1209 11y ago
  Another question along these lines, since OP's question seems well-answered: If a startup employee has 90 days to exercise options after leaving a startup, what happens if a liquidity event happens during that 90-day window? Specifically, I'm wondering whether a cashless transaction is possible, particularly if it is a cash deal.
• desdiv 11y ago
  How does the tax situation change if you're a non-resident alien during the whole process? Is there any difference in the tax rates?
• grellas 11y ago
  Here is a thread in which I explain various technical points relating to the tax treatment of stock options: https://news.ycombinator.com/item?id=2623777 https://news.ycombinator.com/item?id=2623777 Adding to this on your specific question about loss: when you exercise options, your purchase price becomes the basis in your stock; if the company fails and goes bankrupt, for example, you can deduct the amount of the basis as a capital loss; this means you can offset this amount (i.e., deduct it outright) against other capital gains you might have in that same year or in future years (as part of a capital loss carryforward) but you cannot otherwise deduct it outright; in general, federal tax law in such cases allows you to deduct it at the rate of up to $3,000 in any given year, with the rest carried forward for future potential deduction (this is the capital-loss carryforward). Hope this helps.
• caseysoftware 11y ago
  This is the single best source I've ever read on options, exercising them, etc: http://www.amazon.com/Introduction-Stock-Options-David-Weekly-ebook/dp/B0055PQ4H8 http://www.amazon.com/Introduction-Stock-Options-David-Weekl... When I followed the recommendations (after checking with my accountant), I saved thousands of dollars and I'm still benefitting from that even now. My only criticism is that I wish I had read it about 2 years earlier.
• bharad 11y ago
  This article is more than a decade old, but a lot of content is still relevant. http://web.mit.edu/tytso/www/OPTIONS-HOWTO/OPTIONS-HOWTO.html http://web.mit.edu/tytso/www/OPTIONS-HOWTO/OPTIONS-HOWTO.htm...
• hkmurakami 11y ago
  I have started to write a series of posts on my blog regarding this very topic. So timely question. > I get that if I leave my startup today I have 90 days to exercise my options. The number of days to exercise depends on your contract. The typical number is 45 days. Pinterest's number for employees that have more than 2 years of service is 7 years. This number is not set by law, and can be set to anything the founders/investors agree to. The 90 day number you are thinking of is the law stating that ISOs become nonincentive options when not exercised after 90 days after termination of employment. > I get that I'll have to pay the agreed 'strike price' You pay the "strike price" * "number of options you wish to exercise" > Would I be paying tax as if I'd made capital gains in the amount of the delta between the strike price and the stock's value today? Would the stock's value today be based on the company's valuation at the most recent round of funding? Assuming you were awarded ISOs, you do not owe capital gains tax under "regular income tax" upon exercise. You only owe taxes upon sale of your stock that you have attained through exercise, at some future date. However, depending on your amount of gains, other income, and your effective tax rate, you may owe tax under AMT. Consult a CPA with experience in this. It should be simple for them. (I believe you get some tax credits for this AMT payment when you end up selling your shares in the future) The company's stock's value is set by the BoD meetings. This may or may not be the same as the previous round of funding. > If the company goes on to raise more VC funding, would I be liable in future years for the 'capital gains' on this stock? You are only liable for "capital gains" when you sell the stock. > If the company went on to fail, would I be entitled to tax breaks for loss of stock? Good question! I hadn't thought of this one. My guess here would be "yes", you would be able to claim a capital loss equal to the amount of money you paid to acquire your stock.
• thejerz 11y ago
  Many startups have a clause in their offer letter that promises to "recommend that N options be granted at the next board meeting." It's a formality, but it doesn't always happen. Make sure those options were actually granted before you think about how to exercise them.
• arturhoo 11y ago
  Is anyone able to give some insights for non US citizens that have options of an American company but work overseas with no american employment contracts. Thanks!