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>Exercising risklessly is safe It may be safe, but it isn't free. As with most other things, you pay a risk premium -- in this case, in the form of failure to

>Exercising risklessly is safe It may be safe, but it isn't free. As with most other things, you pay a risk premium -- in this case, in the form of failure to qualify for capital gains tax treatment on the resulting gain, because you didn't exercise in time to hold the underlying stock for more than one year. Depending on the amount, this difference can be quite significant. You do your own taxes so probably know all this already, but here's a simple example[1] anyway. Let's say you "risklessly" exercise options with a strike price of 100 and a FMV (tax-lawyer speak for fair market value) of 1000. You have immediate gain of 900 -- and because you didn't hold the shares for >1 year, all 900 is Ordinary Income, generally taxed at higher rates than capital gains. (Top federal OI rate is something like 39% last time I checked vs something like 17% for cap gains.) Assuming the OI rate is 39% and the CG rate is 17%, you pay tax of .39 * 900 = 351, for total post-tax cash of 900 - 351 = 549. What if, instead, you had exercised speculatively, more than 1 year prior? You'd still have taxable gain on 900, but because you'd have held the stock for more than one year (and met some other qualifying factors I won't bother explaining here), your tax bill would be 17% -- meaning that you'd pay .17 * 900 = 153 in taxes, and keep cash of 900-153 = 847. Not a huge difference when we're talking about gain in the hundreds, but adds up quickly if you're in line for tens or hundreds of thousands or more. It's really just a question of how you evaluate different kinds of risks, and what you want to pay to hedge them. If you want to balance your tax bite against the risk that your company goes under or otherwise fails to deliver, you may still want to exercise early, but only partially. [1] I'm eliding a few things and making some assumptions. Not legal advice, talk to a real tax attorney before making decisions, etc.

ewams 11y ago
In the US, do you pay taxes when you exercise your option to buy the stock? For you example, say I exercise my option to by 1 at strike price of $100 in 2015. I hold on to it and sell it in 2017 for the FMV of $1000. Do you only pay the capital gains tax of the $900 gain? Ignore state rules, just at the fed.
- idunno246 11y ago
  Lets say the fmv in 2015 is $500, and your strike price $100. If they are ISO, in 2015 you own no regular tax on it(thats the Incentivized). In 2017 you owe capital gains on $900. However, AMT(alternative minimum tax) doesnt recognize ISO. So in 2015, you have to calculate AMT, which $400 counts towards. This is basically a no-deduction(except a high standard deduction) flat tax, you potentially owe 26-35% on that 400. Even though you didnt sell anything - this is where people get screwed. So lets say you paid $100 in AMT. In 2017, you still owe capital gains tax on the whole $900, but you calculate AMT and claim the difference, up to $100, as a credit - the difference should be >100. You can actually claim this credit every year until previously paid AMT runs out, but most likely the difference wont be sizable enough until you sell.
  - sokoloff 11y ago
    For completeness, on ewams' question: if the options are non-qualified (NQSO instead of ISO) and FMV at the time of exercise was $500, you would owe ordinary income tax on $400 ($500-$100) of income in 2015 tax year and long-term capital gains on $500 ($1000-$500) in 2017 tax year. Not a tax pro; this is not tax advice; yada yada.
    - ewams 11y ago
      Do companies actually change the type of options to NSO, ISO, RSA, RSU, etc? Or are they usually stagnant and non-negotiable? Thanks for responding folks.
      - sokoloff 11y ago
        ISOs have a set of specific qualities that must be present to be treated as ISOs. Most established companies issuing options will be NQSOs. RSUs are a lower volatility version, but with less flexibility in terms of timing (I can't delay "exercising" my RSUs in terms of timing when I recognize the income). You can make ISOs be treated approximately as NQSOs, but otherwise, you're generally getting from an established program and within a company, you don't have to be prepped to negotiate one type vs the other. Over time, the company will no longer be able to issue ISOs and may implement other programs, but they will tend to be "one type fits all" in general.
peter303 11y ago
A number of people got screwed six or seven figures in the early 200s dot.crash waiting the year for LTGC tax rates or during the sales lockout. There were a lot IPOs in the late 1990s and a lot of worthless stock a year or two after that.

ewams 11y ago

In the US, do you pay taxes when you exercise your option to buy the stock? For you example, say I exercise my option to by 1 at strike price of $100 in 2015. I hold on to it and sell it in 2017 for the FMV of $1000. Do you only pay the capital gains tax of the $900 gain? Ignore state rules, just at the fed.

idunno246 11y ago
Lets say the fmv in 2015 is $500, and your strike price $100. If they are ISO, in 2015 you own no regular tax on it(thats the Incentivized). In 2017 you owe capital gains on $900. However, AMT(alternative minimum tax) doesnt recognize ISO. So in 2015, you have to calculate AMT, which $400 counts towards. This is basically a no-deduction(except a high standard deduction) flat tax, you potentially owe 26-35% on that 400. Even though you didnt sell anything - this is where people get screwed. So lets say you paid $100 in AMT. In 2017, you still owe capital gains tax on the whole $900, but you calculate AMT and claim the difference, up to $100, as a credit - the difference should be >100. You can actually claim this credit every year until previously paid AMT runs out, but most likely the difference wont be sizable enough until you sell.
- sokoloff 11y ago
  For completeness, on ewams' question: if the options are non-qualified (NQSO instead of ISO) and FMV at the time of exercise was $500, you would owe ordinary income tax on $400 ($500-$100) of income in 2015 tax year and long-term capital gains on $500 ($1000-$500) in 2017 tax year. Not a tax pro; this is not tax advice; yada yada.
  - ewams 11y ago
    Do companies actually change the type of options to NSO, ISO, RSA, RSU, etc? Or are they usually stagnant and non-negotiable? Thanks for responding folks.
    - sokoloff 11y ago
      ISOs have a set of specific qualities that must be present to be treated as ISOs. Most established companies issuing options will be NQSOs. RSUs are a lower volatility version, but with less flexibility in terms of timing (I can't delay "exercising" my RSUs in terms of timing when I recognize the income). You can make ISOs be treated approximately as NQSOs, but otherwise, you're generally getting from an established program and within a company, you don't have to be prepped to negotiate one type vs the other. Over time, the company will no longer be able to issue ISOs and may implement other programs, but they will tend to be "one type fits all" in general.

peter303 11y ago

A number of people got screwed six or seven figures in the early 200s dot.crash waiting the year for LTGC tax rates or during the sales lockout. There were a lot IPOs in the late 1990s and a lot of worthless stock a year or two after that.