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Alternative Minimum Tax (AMT)
When exercising ISOs, you may need to pay an alternative minimum tax (AMT). The AMT is a tax that builds up in conjunction with your normal tax bill. At the time of filing, you will be required to pay either the AMT or your normal tax bill - whichever is higher. While most Americans will never pay the AMT over their normal tax amounts, those with ISOs must be cautious as exercising adds to your AMT. If you exercise enough ISOs, you may get stuck paying more in taxes via the AMT.
The AMT is a tax system that was established in 1979 to prevent Americans from finding legal loopholes for not paying taxes. It helped ensure that every American was paying some amount in state and federal taxes. So, while some could find loopholes to keep their tax bills low, they could not avoid paying the AMT.
If you have paid the AMT in the past, you may be eligible for a reduced tax bill in the current year via the AMT credit. The AMT credit is like a rebate or refund you can receive after paying the AMT in previous years.
To receive the AMT credit, our advisors will review your past tax returns to a.) confirm you paid the AMT and b.) ensure you have not previously claimed the credit. If both cases are true, we can help you claim while filing your current taxes.
Finding the funds to exercise your stock options can be difficult and expensive. If this is the case for you, a cashless exercise is a great option. With a cashless exercise, you sell your shares immediately after your purchase. You are using the money you make from the sale to cover your exercise expenses.
Cashless exercise is a great low-risk option. However, it is important to know that this is not an option for you if you left the company prior to the IPO, and you will also have to pay the maximum tax rate. The profit you make from selling will be taxed at your normal income tax rate for both state and federal, which can be over 50% in California. If you are concerned about these drawbacks, you may consider exercising pre-IPO instead. Our advisors will review your stock options and financial situation comprehensively to determine whether a cashless exercise is the best option for you.
Early exercising is when you exercise stock options before they vest. Not all companies allow for it, but if yours does, you may consider it because it can keep your exercise costs low, and you may pay less in taxes.
Early exercising is most beneficial before the valuation of company shares. As a company grows and becomes more successful, the valuation of company shares increases and in turn, your tax bill at exercise also increases. With early exercise, you are paying taxes on an earlier, lower valuation. Our advisors will take in all considerations regarding your stock options and determine whether exercising early is the right option for you.
An Exchange Fund is a potential solution for clients with one or more large-concentrated stock positions, often with a low-cost basis. Rather than realizing a capital gain through immediate sale of the stock positions, clients can diversify their holdings by exchanging their stock shares for shares of an Exchange Fund. A client must have at least $1,000,000 of acceptable stocks.
Incentive Stock Option (ISO)
A form of equity compensation offered to employees of a company. When you have ISOs from a company, you have the right to buy shares at a predetermined price (exercise price) that is often below the current market price. You also have greater tax benefits - exercising an ISO is ignored when calculating regular federal income tax (unlike NSOs). It is treated as income solely to calculate alternative minimum tax (AMT).
Non-Qualified Stock Option (NSO)
Similar to ISOs, NSOs are a form of equity compensation offered to employees of a company where they can buy shares at a predetermined price (exercise price) that is often below the current market price. Because the spread between exercise price and current stock price will be reported on your W-2, you will pay the standard income tax rate on this difference (unlike ISOs).
Qualified Opportunity Zone
The 2017 Tax Cuts and Jobs Act established the Qualified Opportunity Zone program to provide a tax incentive for private, long-term investment in economically distressed communities. Investors in these programs are given an opportunity to defer and potentially reduce tax on recognized capital gains.
What is an Opportunity Zone?
An Opportunity Zone is a community nominated by the state and certified by the Treasury Department as qualifying for this program. As of June 14, 2018, the department certified zones in all 50 states, Washington, D.C., and U.S. territories. There are approximately 8,700 Opportunity Zones nationwide. A list can be found at https://www.cdfifund.gov/pages/opportunity-zones.aspx.
Restricted Stock Unit (RSU)
Another form of equity compensation offered to an employee by a company. RSUs are shares of a company that are simply given to an employee and do not need to be exercised like ISOs and NQSOs. However, there is usually a vesting period that an employee must have to wait before RSUs are of any value. RSUs become of value on the vesting date as the employee then no longer holds RSUs, but rather owns shares of company stock. For example, if you have 1,000 RSUs that vest on January 1st and your company’s shares are trading at $10 on January 1st, then you would now own 1,000 shares of your company’s stock worth $10,000.
As an employee, your company automatically withholds money from your paycheck and sends it to the government as taxes on your behalf. This is known as tax withholding. When it is time to file your taxes in the spring, you calculate your tax bill and it is compared against what was withheld. If more money was withheld than your actual tax bill, you will receive a refund from the state or federal government for the difference.
If you exercise your stock options early, you will need to file an 83(b) election with the IRS within 30 days. With the 83(b) election, you are opting to pay tax on the valuation of the company’s shares today versus on the valuation in the future.
Filing an 83(b) requires individuals to send a completed form and cover letter (available online) to both the IRS office and their company. Our advisors will assist with this process to ensure all filing requirements are met before the 30-day deadline.
Tushar Kumar and Vishal Kumar are registered representatives with and securities offered through LPL Financial, Members FINRA/SIPC.