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>> One of those former employees paid about $100,000 to exercise more than 20,000 incentive stock options (ISOs), plus a tax bill of over $200,000. The other pa

>> One of those former employees paid about $100,000 to exercise more than 20,000 incentive stock options (ISOs), plus a tax bill of over $200,000. The other paid about $70,000 to exercise about 5,000 ISOs, and then about $160,000 in taxes. Maybe it's a common knowledge amongst the Silicon Valley engineers, but for those of us who are not in startup, could someone please explain how this is possible? Specifically, in what logic would you owe more tax to exercise the option(which amounts to purchasing at this point) for half the amount of tax you'll pay? How does purchasing something of $X force you to pay $2X in taxes? I've combed through this thread for answers and it seems like a commonly understood problem.

niuzeta 9y ago
Responding to my own inquiry, from the article: > Under current tax law, the income from exercising ISOs, a special type of option typically reserved for executives and senior employees, falls under an alternative tax calculation designed to prevent high-earners from using deductions to avoid paying tax. Non-qualified stock options, more commonly awarded to regular employees, are taxed the year they’re exercised on the gain in the stock.
deleted 9y ago
[deleted]
adt2bt 9y ago
I'm pretty sure it's because his strike price was far lower than the value of those shares. For example, if he pays $100 to get 20 shares at $5/share, but the shares are worth $100 each, he just got $2,000 and will need to pay taxes on that larger amount.
- niuzeta 9y ago
  Right. So in the eyes of IRS you just didn't buy something, you in fact gained in net worth, except all those new assets you've purchased is illiquid.
  - chii 9y ago
    except the valuation is a private estimate. why can't the tax be levied when the same stock is liquidated into cash? then you'd get a real price, rather than an estimate.
    - kwillets 9y ago
      It adjusts to the price on that day far in the future when employees get out of lockup, but if it spans tax years you're still screwed. Basically, when you have gains, you only ensure realistic taxes when you exercise and sell within the same tax year; otherwise you take a huge risk.
    - jsjohnst 9y ago
      There’s regulations around the 409a valuation of the company, it’s not completely based on the unicorn fairy dust that VCs use to value a company. Admittedly 409a valuations are far from perfect for many reasons, but they aren’t the same as the valuations you commonly hear when a company closes a round.
SubFuze 9y ago
https://www.nceo.org/articles/stock-options-alternative-minimum-tax-amt https://www.nceo.org/articles/stock-options-alternative-mini... does a decent job explaining it. Essentially, you exercise at the price you were granted the options, but if the value has gone up since then, you're taxed (AMT) on the delta between the exercise price and the current value.
ubernostrum 9y ago
At the time you exercise the option, the IRS asks for the difference between the price you paid to exercise, and the estimated value of a share of the stock (based on the company's latest 409a valuation). If those numbers are different, you owe tax on the amount of the difference. The IRS doesn't care whether you actually have the ability to realize the gain by selling stock; they just care that you paid $X and now own something worth $(X + N) where N is positive. This is a massive issue in this era of companies which never allow their stock to freely circulate, and mostly is based on the previous eras in which a startup that granted options would actually go public at some point and allow the holders of the options to sell their stock for money.
staikken 9y ago
Isn't the $100,00K in this case the premium on the option? Taking the price SoftBank is offering, $33, those 20,000 shares are worth 660,000 so a net profit of 560,000 and a tax of about 35%. This seems a little high still so there might be something I'm missing.
gshulegaard 9y ago
Disclaimer: This a lay-man's understanding... So you join a shiny new "start up" and they offer you some stock options as part of their compensation package. This is typically done to improve compensation without requiring additional liquidity which is typically a limited resource for a start up. These "ISOs" (Incentive Stock Options) are usually option agreements where the company agrees to let you "purchase" shares of the company in the future at a strike price equal to current valuation. So even if you "exercise" (purchase) the stock 2+ years later you pay the same price you would have if you had purchased the stock on your first day at the company. The problem with tax here is that in those 2+ years before exercising your "options" your company may have grown/raised more money with greater valuations...so the value of the stock may have doubled, tripled, or increased in even greater value. Well lucky you! According to your ISO you can purchase the stock for the value it was worth 2+ years ago! "Hold on just a minute," the IRS says, if you purchase a share for $5 that is "valued" at $25 now...what you actually have is an immediate realized gain of $20. Since you spent $5 and acquired an asset worth $25...you should be taxed AMT on the realized gain of $20. Makes sense. The issue is with "valued" here. In the case of pre-IPO startups the stock you purchased cannot really be sold. Value of a pre-IPO company's stock is more or less correlated to what investors agreed to in your last round of funding (e.g. I <insert_investor_here> agree to give your company $XXXXXXXX for YY% of your company). But at the end of the day, you pay $5 for a piece of paper that says you have stock in a company that is estimated to have the value of $25...but isn't actually worth anything since you can't actually turn it into money. You can't sell that piece of paper for $25 (in fact, you can't sell that paper at all). Which means you end up owing taxes on a $20 realized gain on an asset you can't sell. That is, you can't turn around and sell some of that newly acquired stock to pay your tax...again it's not really worth anything...it's estimated value is just higher than what you paid for it. So the question is...where do you come up with the money to pay this tax? Well, in the case of these individuals, you go into debt.
- chii 9y ago
  The strange thing to me is why you get taxed before the sale of the asset (i.e., at the time of purchase).
  - 9y ago

niuzeta 9y ago

Responding to my own inquiry, from the article: > Under current tax law, the income from exercising ISOs, a special type of option typically reserved for executives and senior employees, falls under an alternative tax calculation designed to prevent high-earners from using deductions to avoid paying tax. Non-qualified stock options, more commonly awarded to regular employees, are taxed the year they’re exercised on the gain in the stock.

deleted 9y ago

[deleted]

adt2bt 9y ago

I'm pretty sure it's because his strike price was far lower than the value of those shares. For example, if he pays $100 to get 20 shares at $5/share, but the shares are worth $100 each, he just got $2,000 and will need to pay taxes on that larger amount.

niuzeta 9y ago
Right. So in the eyes of IRS you just didn't buy something, you in fact gained in net worth, except all those new assets you've purchased is illiquid.
- chii 9y ago
  except the valuation is a private estimate. why can't the tax be levied when the same stock is liquidated into cash? then you'd get a real price, rather than an estimate.
  - kwillets 9y ago
    It adjusts to the price on that day far in the future when employees get out of lockup, but if it spans tax years you're still screwed. Basically, when you have gains, you only ensure realistic taxes when you exercise and sell within the same tax year; otherwise you take a huge risk.
  - jsjohnst 9y ago
    There’s regulations around the 409a valuation of the company, it’s not completely based on the unicorn fairy dust that VCs use to value a company. Admittedly 409a valuations are far from perfect for many reasons, but they aren’t the same as the valuations you commonly hear when a company closes a round.

SubFuze 9y ago

https://www.nceo.org/articles/stock-options-alternative-minimum-tax-amt https://www.nceo.org/articles/stock-options-alternative-mini... does a decent job explaining it. Essentially, you exercise at the price you were granted the options, but if the value has gone up since then, you're taxed (AMT) on the delta between the exercise price and the current value.

ubernostrum 9y ago

At the time you exercise the option, the IRS asks for the difference between the price you paid to exercise, and the estimated value of a share of the stock (based on the company's latest 409a valuation). If those numbers are different, you owe tax on the amount of the difference. The IRS doesn't care whether you actually have the ability to realize the gain by selling stock; they just care that you paid $X and now own something worth $(X + N) where N is positive. This is a massive issue in this era of companies which never allow their stock to freely circulate, and mostly is based on the previous eras in which a startup that granted options would actually go public at some point and allow the holders of the options to sell their stock for money.

staikken 9y ago

Isn't the $100,00K in this case the premium on the option? Taking the price SoftBank is offering, $33, those 20,000 shares are worth 660,000 so a net profit of 560,000 and a tax of about 35%. This seems a little high still so there might be something I'm missing.

gshulegaard 9y ago

Disclaimer: This a lay-man's understanding... So you join a shiny new "start up" and they offer you some stock options as part of their compensation package. This is typically done to improve compensation without requiring additional liquidity which is typically a limited resource for a start up. These "ISOs" (Incentive Stock Options) are usually option agreements where the company agrees to let you "purchase" shares of the company in the future at a strike price equal to current valuation. So even if you "exercise" (purchase) the stock 2+ years later you pay the same price you would have if you had purchased the stock on your first day at the company. The problem with tax here is that in those 2+ years before exercising your "options" your company may have grown/raised more money with greater valuations...so the value of the stock may have doubled, tripled, or increased in even greater value. Well lucky you! According to your ISO you can purchase the stock for the value it was worth 2+ years ago! "Hold on just a minute," the IRS says, if you purchase a share for $5 that is "valued" at $25 now...what you actually have is an immediate realized gain of $20. Since you spent $5 and acquired an asset worth $25...you should be taxed AMT on the realized gain of $20. Makes sense. The issue is with "valued" here. In the case of pre-IPO startups the stock you purchased cannot really be sold. Value of a pre-IPO company's stock is more or less correlated to what investors agreed to in your last round of funding (e.g. I <insert_investor_here> agree to give your company $XXXXXXXX for YY% of your company). But at the end of the day, you pay $5 for a piece of paper that says you have stock in a company that is estimated to have the value of $25...but isn't actually worth anything since you can't actually turn it into money. You can't sell that piece of paper for $25 (in fact, you can't sell that paper at all). Which means you end up owing taxes on a $20 realized gain on an asset you can't sell. That is, you can't turn around and sell some of that newly acquired stock to pay your tax...again it's not really worth anything...it's estimated value is just higher than what you paid for it. So the question is...where do you come up with the money to pay this tax? Well, in the case of these individuals, you go into debt.

chii 9y ago
The strange thing to me is why you get taxed before the sale of the asset (i.e., at the time of purchase).
- 9y ago