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> When you get issued stock options at a company, you immediately become liable for taxes on them, since they are treated as income. This is false, right? It's

> When you get issued stock options at a company, you immediately become liable for taxes on them, since they are treated as income. This is false, right? It's only taxable on exercise. That or I know 1,000s of people at major companies that owe back taxes.

PaulDavisThe1st 6y ago
In the 1990s, I knew dozens of people who faced major financial problems because they immediately owed taxes on options they had just exercised, on shares that were not tradable. These were just regular developers (or in some cases, shipping crew), and they didn't have $50-500k sitting around to cover taxes like that. Maybe the rules have been changed since then? I do know that by the early 2000's there were financial services companies offering wierd loans to help cover the taxes (obviously using the stocks as collateral).
- azinman2 6y ago
  This is the difference between RSUs, NSOs, and ISOs. ISOs don't make you pay taxes until you exercise it (a qualifying event), which means you actually took this piece of paper and converted it into tangible value. I'm not sure how they could have exercised it and not had it turn into cash (perhaps their company got acquired and they got options of another non-IPO'd company?).
  - PaulDavisThe1st 6y ago
    Let's put it like this. The year after I exercised my one and only set of amzn stock options, I owed US$43k in taxes based on their nominal value. The stock was not publically traded at the time, and I had to find savings to cover the tax bill. I retained the piece of paper and started selling later that year after the IPO. At least one other early hire at amzn owed a lot more than this.
    - fossuser 6y ago
      Yeah - options are taxed on exercise, not on grant (that’s the dispute with your original comment). Also, you’re taxed on the spread at exercise between the strike price and the fair market value at the time of exercise. If you’re able to exercise when the shares are granted (which early employees can often do by early exercising unvested shares) then there is no spread and there is no tax (at time of exercise, you still pay tax when you eventually sell the shares). Doing this and filing an 83b election with the IRS is important for people joining a startup where they hold lots of equity that’s valued near zero. It’s even a little more complicated than that if you get ISOs since you can exercise some of them tax free until you hit AMT (but AMT has not increased over time so this is less useful than it used to be). NSOs don’t have this ability. RSUs are different and you do get taxed on grant and some are withheld to cover (FB started this and they’re colloquially called FB-style RSUs). This is a relatively recent invention that started because private companies with high valuations had options with strikes too expensive for normal employees to exercise prior to the mandatory ten year expiration. Also old employees who held the option contracts wouldn’t be able to pay the exercise tax on the spread you mention and would hit the 10yr expiration (at which point they need to make a loan shark deal or risk floating a lot of cash). This used to not be an issue because companies didn't stay private this long. With RSUs employees don’t have to worry about any of this, but they lose more on grant to income tax than they could by exercising and holding options optimally. RSUs aren’t strictly better though because if you can exercise options you can hold the stock for 1yr and get long term cap gains which is 15% up to 400k and 20% after. This is a lot more potential upside than just getting hit with income tax. Though in CA you still get hit with a large percentage state income tax on it anyway. (13% after 1M I think). All of the above commentary is unrelated to a wealth tax (or capping net worth) which I think is dumb policy. This grew into a kind of long comment, but if you’re dealing with equity it’s worth learning this stuff for yourself since leveraging equity effectively is probably the best way to actually get wealth in a timeframe shorter than a lifetime of index funds investing.
    - azinman2 6y ago
      What did you exercise them to do other than sell?
- throwaway09223 6y ago
  "they immediately owed taxes on options they had just exercised" On exercise yes, but not on issue. I think you're mixing up people buying their options (exercise) with issuance of the options. No taxes are owed at grant or vest on options, whether NSO or ISO. Upon exercise (buying - regardless of whether there's a sale) of NSO a tax is owed on the spread between the FMV (usually the 409a valuation, if pre-ipo) and the strike price at grant. This can be considerable and I'm sure is the tax event you're thinking of. Savvy employees with a cooperative employer often exercise at grant time -- before the options vest -- writing a check almost immediately after hire. This is an early exercise. If this takes place before the value changes (before the board updates the 409a valuation) then there is a taxable event but the spread is $0. The employee then follows up with an 83(b) election to notify the IRS that they wished to be taxed now, rather than later at vest, which ensures that income tax on the spread is never paid. It all becomes regular capital gains.
sprice 6y ago
I only know Canada where one owes taxes when an event occurs. Being issued stock is not an event. Exercising options for stock is an event. IANAL nor an accountant and this is not financial advice.

PaulDavisThe1st 6y ago

In the 1990s, I knew dozens of people who faced major financial problems because they immediately owed taxes on options they had just exercised, on shares that were not tradable. These were just regular developers (or in some cases, shipping crew), and they didn't have $50-500k sitting around to cover taxes like that. Maybe the rules have been changed since then? I do know that by the early 2000's there were financial services companies offering wierd loans to help cover the taxes (obviously using the stocks as collateral).

azinman2 6y ago
This is the difference between RSUs, NSOs, and ISOs. ISOs don't make you pay taxes until you exercise it (a qualifying event), which means you actually took this piece of paper and converted it into tangible value. I'm not sure how they could have exercised it and not had it turn into cash (perhaps their company got acquired and they got options of another non-IPO'd company?).
- PaulDavisThe1st 6y ago
  Let's put it like this. The year after I exercised my one and only set of amzn stock options, I owed US$43k in taxes based on their nominal value. The stock was not publically traded at the time, and I had to find savings to cover the tax bill. I retained the piece of paper and started selling later that year after the IPO. At least one other early hire at amzn owed a lot more than this.
  - fossuser 6y ago
    Yeah - options are taxed on exercise, not on grant (that’s the dispute with your original comment). Also, you’re taxed on the spread at exercise between the strike price and the fair market value at the time of exercise. If you’re able to exercise when the shares are granted (which early employees can often do by early exercising unvested shares) then there is no spread and there is no tax (at time of exercise, you still pay tax when you eventually sell the shares). Doing this and filing an 83b election with the IRS is important for people joining a startup where they hold lots of equity that’s valued near zero. It’s even a little more complicated than that if you get ISOs since you can exercise some of them tax free until you hit AMT (but AMT has not increased over time so this is less useful than it used to be). NSOs don’t have this ability. RSUs are different and you do get taxed on grant and some are withheld to cover (FB started this and they’re colloquially called FB-style RSUs). This is a relatively recent invention that started because private companies with high valuations had options with strikes too expensive for normal employees to exercise prior to the mandatory ten year expiration. Also old employees who held the option contracts wouldn’t be able to pay the exercise tax on the spread you mention and would hit the 10yr expiration (at which point they need to make a loan shark deal or risk floating a lot of cash). This used to not be an issue because companies didn't stay private this long. With RSUs employees don’t have to worry about any of this, but they lose more on grant to income tax than they could by exercising and holding options optimally. RSUs aren’t strictly better though because if you can exercise options you can hold the stock for 1yr and get long term cap gains which is 15% up to 400k and 20% after. This is a lot more potential upside than just getting hit with income tax. Though in CA you still get hit with a large percentage state income tax on it anyway. (13% after 1M I think). All of the above commentary is unrelated to a wealth tax (or capping net worth) which I think is dumb policy. This grew into a kind of long comment, but if you’re dealing with equity it’s worth learning this stuff for yourself since leveraging equity effectively is probably the best way to actually get wealth in a timeframe shorter than a lifetime of index funds investing.
  - azinman2 6y ago
    What did you exercise them to do other than sell?
throwaway09223 6y ago
"they immediately owed taxes on options they had just exercised" On exercise yes, but not on issue. I think you're mixing up people buying their options (exercise) with issuance of the options. No taxes are owed at grant or vest on options, whether NSO or ISO. Upon exercise (buying - regardless of whether there's a sale) of NSO a tax is owed on the spread between the FMV (usually the 409a valuation, if pre-ipo) and the strike price at grant. This can be considerable and I'm sure is the tax event you're thinking of. Savvy employees with a cooperative employer often exercise at grant time -- before the options vest -- writing a check almost immediately after hire. This is an early exercise. If this takes place before the value changes (before the board updates the 409a valuation) then there is a taxable event but the spread is $0. The employee then follows up with an 83(b) election to notify the IRS that they wished to be taxed now, rather than later at vest, which ensures that income tax on the spread is never paid. It all becomes regular capital gains.

sprice 6y ago

I only know Canada where one owes taxes when an event occurs. Being issued stock is not an event. Exercising options for stock is an event. IANAL nor an accountant and this is not financial advice.