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Vested is not exercised. Options vest, but you have to exercise them to purchase the underlying shares. This is nominally cheap, but from the IRS’ perspective

Vested is not exercised. Options vest, but you have to exercise them to purchase the underlying shares. This is nominally cheap, but from the IRS’ perspective you have just spent $1 to purchase a share worth $100, so that’s $99 of income. Multiply by a large number of options and you can easily have a real multimillion dollar tax bill even though you have no way to sell the shares to recoup their value. Worse, if the company loses its value before you can sell, you’re still out those taxes with zero recourse. It’s an enormous risk. If you leave a company with vested but unexercised shares, you generally forfeit them.

crazygringo 1y ago
Sure, but I'm not really clear on what that has to do with the situation described? And he calls them vested shares though, not vested options, though maybe he's incorrect. And it's not like you forfeit them instantly after leaving anyways. You usually have at least 90 days. And the fact that the value of the company is so much lower now is favorable, if you think the value will recover. But again, none of this has anything to do with the "1% payout" here that is still totally unexplained.
- masterjack 1y ago
  It’s possible that in the Google deal you had to agree to sell back the shares (at a low value like par or original strike price) and the 1% refers to either those proceeds or the size of the Google employment package. If you didn’t agree then you would be left holding your shares of a company that is now gutted.
  - crazygringo 1y ago
    > It’s possible that in the Google deal you had to agree to sell back the shares But how could Google require that? > If you didn’t agree then you would be left holding your shares of a company that is now gutted. Which is what is sounds like he wound up doing anyways? Which I don't even understand why.
    - adgjlsfhk1 1y ago
      Google can just refuse to hire you if you don't
      - crazygringo 1y ago
        I've literally never heard of a company demanding you give up shares in another company as a precondition of being hired, for an engineering role. At the executive level they may not want you holding shares in a direct competitor because it presents a conflict of interest. But even then you generally have a period to divest. Can nobody explain what the actual demand was here? What did Google offer vs. what did they demand, and why? And why would Google be buying your shares...? None of this makes any sense the way it's been presented.
        hamburglar 1y ago
        How would they even know if you were still holding those shares in another company? This scenario is pure fantasy.
naveen99 1y ago
Doesn’t income happen when you sell the shares ? What is the cost basis of the shares you purchase if not the strike price of the option ?
- cyanydeez 1y ago
  https://taxsharkinc.com/when-are-vested-shares-taxable/ https://taxsharkinc.com/when-are-vested-shares-taxable/ Its different for vesting. Othrrwise even more toxic greed and tax avoidance would occur.
- toast0 1y ago
  AMT income happens when the option is exercised (vests and paid for), the difference between the value and the strike price is income at that time. The AMT cost basis is the value at that time ... or you can think of it as the strike price plus the amount of income. At the same time, if it's an ISO option, there is no assessment of ordinary tax until the stock is disposed. If there's a merger and the proper forms are followed, you can be issued stock from the acquirer that retains the basis (the strike price) of the original shares. If the forms are not followed, the acquisition is a taxable disposition. There's a credit for the difference between AMT tax and ordinary tax on ISOs, but it can take many years for that to fully work out, and you have to have paid the AMT in the meantime. Early exercise with 83(b) at time of grant (or while the value hasn't changed) or exercise-and-sell make the taxes make the taxes simplest, but tax simplicity isn't always the best strategy.
ProfessorLayton 1y ago
While you're right that exercising options can be very expensive and are a risky tax bet, we're talking about employee #2 in this case. They should've been able to buy in early at a low price and tax bill if they really believed in the company: - Jan 2021: 3M seed round - Jan 2024: Series B valuing the company at 500M That's 3 years of vesting below a 1B company valuation, and 75% of a typical vesting schedule. There was plenty of opportunity to buy when valuations were low. There's also 83(b) election that allows one to prepay tax liabilities on stock options before they vest. Not buying stock options or doing a 83(b) election is also a bet that can place a cap on losses if the company goes downhill, but the risk flips if everything goes right.
- toast0 1y ago
  You want to say exercising options. Buying options is paying to have an option; you can easily buy options on publically traded stocks, for example. Exercising options is delivering money that covers the strike price to receive the shares... or delivering the shares to receive the strike price, if it was a sell/put option (which employment related options wouldn't be)
- stouset 1y ago
  I encourage you to put yourself in that person's shoes. It is never a simple decision. Yes, there is plenty of opportunity to exercise when valuations were low. But that also means you're buying before there's clear evidence that the company will be successful. It also still means you're out the cash to exercise the options before there's a market for those options and before you know that the company will actually go public and not crater for whatever reason. You also have no idea how much your shares will be diluted. Yes, exercising on day 1 optimizes your outcome in the case of a successful exit. But it is absolutely comically a poor choice for the 95% of cases where your equity ends up being worth next to nothing.
  - ProfessorLayton 1y ago
    I'm speaking from experience. Yes, it means buying in before there's clear evidence of success, that's the risk! The lower the risk the lower the reward. Waiting until the company is worth billions of dollars before buying its stock is one of several options available, and each has its own risk/reward profile.

crazygringo 1y ago

Sure, but I'm not really clear on what that has to do with the situation described? And he calls them vested shares though, not vested options, though maybe he's incorrect. And it's not like you forfeit them instantly after leaving anyways. You usually have at least 90 days. And the fact that the value of the company is so much lower now is favorable, if you think the value will recover. But again, none of this has anything to do with the "1% payout" here that is still totally unexplained.

masterjack 1y ago
It’s possible that in the Google deal you had to agree to sell back the shares (at a low value like par or original strike price) and the 1% refers to either those proceeds or the size of the Google employment package. If you didn’t agree then you would be left holding your shares of a company that is now gutted.
- crazygringo 1y ago
  > It’s possible that in the Google deal you had to agree to sell back the shares But how could Google require that? > If you didn’t agree then you would be left holding your shares of a company that is now gutted. Which is what is sounds like he wound up doing anyways? Which I don't even understand why.
  - adgjlsfhk1 1y ago
    Google can just refuse to hire you if you don't
    - crazygringo 1y ago
      I've literally never heard of a company demanding you give up shares in another company as a precondition of being hired, for an engineering role. At the executive level they may not want you holding shares in a direct competitor because it presents a conflict of interest. But even then you generally have a period to divest. Can nobody explain what the actual demand was here? What did Google offer vs. what did they demand, and why? And why would Google be buying your shares...? None of this makes any sense the way it's been presented.
      - hamburglar 1y ago
        How would they even know if you were still holding those shares in another company? This scenario is pure fantasy.

naveen99 1y ago

Doesn’t income happen when you sell the shares ? What is the cost basis of the shares you purchase if not the strike price of the option ?

cyanydeez 1y ago
https://taxsharkinc.com/when-are-vested-shares-taxable/ https://taxsharkinc.com/when-are-vested-shares-taxable/ Its different for vesting. Othrrwise even more toxic greed and tax avoidance would occur.
toast0 1y ago
AMT income happens when the option is exercised (vests and paid for), the difference between the value and the strike price is income at that time. The AMT cost basis is the value at that time ... or you can think of it as the strike price plus the amount of income. At the same time, if it's an ISO option, there is no assessment of ordinary tax until the stock is disposed. If there's a merger and the proper forms are followed, you can be issued stock from the acquirer that retains the basis (the strike price) of the original shares. If the forms are not followed, the acquisition is a taxable disposition. There's a credit for the difference between AMT tax and ordinary tax on ISOs, but it can take many years for that to fully work out, and you have to have paid the AMT in the meantime. Early exercise with 83(b) at time of grant (or while the value hasn't changed) or exercise-and-sell make the taxes make the taxes simplest, but tax simplicity isn't always the best strategy.

ProfessorLayton 1y ago

While you're right that exercising options can be very expensive and are a risky tax bet, we're talking about employee #2 in this case. They should've been able to buy in early at a low price and tax bill if they really believed in the company: - Jan 2021: 3M seed round - Jan 2024: Series B valuing the company at 500M That's 3 years of vesting below a 1B company valuation, and 75% of a typical vesting schedule. There was plenty of opportunity to buy when valuations were low. There's also 83(b) election that allows one to prepay tax liabilities on stock options before they vest. Not buying stock options or doing a 83(b) election is also a bet that can place a cap on losses if the company goes downhill, but the risk flips if everything goes right.

toast0 1y ago
You want to say exercising options. Buying options is paying to have an option; you can easily buy options on publically traded stocks, for example. Exercising options is delivering money that covers the strike price to receive the shares... or delivering the shares to receive the strike price, if it was a sell/put option (which employment related options wouldn't be)
stouset 1y ago
I encourage you to put yourself in that person's shoes. It is never a simple decision. Yes, there is plenty of opportunity to exercise when valuations were low. But that also means you're buying before there's clear evidence that the company will be successful. It also still means you're out the cash to exercise the options before there's a market for those options and before you know that the company will actually go public and not crater for whatever reason. You also have no idea how much your shares will be diluted. Yes, exercising on day 1 optimizes your outcome in the case of a successful exit. But it is absolutely comically a poor choice for the 95% of cases where your equity ends up being worth next to nothing.
- ProfessorLayton 1y ago
  I'm speaking from experience. Yes, it means buying in before there's clear evidence of success, that's the risk! The lower the risk the lower the reward. Waiting until the company is worth billions of dollars before buying its stock is one of several options available, and each has its own risk/reward profile.