How to minimize taxes on stock options

Ordinary income tax vs. capital gains tax
Contents:
  1. Related Case Studies
  2. Can you avoid AMT on ISO stock options? (Yes, but there’s a catch)
  3. Related Topics
  4. 14 Ways to Reduce Stock Option Taxes
  5. Stock option planning: Generating value

In other words, the smaller the gap between your strike price and the stock price when you exercise, the more you could benefit from capital gain tax treatment. The tax benefit of ISOs is that you may not have to pay ordinary income tax when you exercise them. Instead, you may only have to pay the lower capital gains tax if you exercise them within—and hold them for—a certain amount of time. This contradicts the graph we just saw above, which actually shows the NSO tax treatment.

Related Case Studies

With ISOs, ordinary income tax goes away. AMT is a different way of calculating your tax obligation. It counts more things as taxable income—including the spread between the price you paid to exercise ISOs and their fair market value when you exercised. If you make more than the AMT exemption amount , you need to calculate your tax obligation both ways and pay the greater of the two calculations. AMT can potentially reach thousands of dollars depending on your income and the difference between your strike price and the FMV of the stock when you exercise.

Talk to a tax professional to learn how to plan for your AMT liability. In order to take advantage of the ISO tax benefit, you need to meet certain holding periods. Specifically, you must hold keep ISOs for at least one year after exercising and two years after your options were granted. If either of these holdings periods is not met for example, if you participate in a tender offer and decide to exercise and sell in one transaction , the difference between your strike price and the sale price of shares will be taxed as ordinary income.

Can you avoid AMT on ISO stock options? (Yes, but there’s a catch)

This applies even if your company gives you more than 90 days to exercise after leaving. As discussed in Part 1 , most companies require you to exercise your vested stock options within a set window of time after leaving the company. This window, called a post-termination exercise PTE period , is usually around 90 days. As you can see in the graph above, the benefit of doing this is that you are minimizing the pre-exercise gain.

Related Topics

This could potentially limit your exposure to AMT. The downside here that you are taking on risk. There is no guarantee that your stock will ever be liquid, so you are paying to buy stock that could one day be worthless. If you choose to exercise options early, you must file an 83 b election to take advantage of the beneficial tax treatment.

You only have 30 days to file this with the IRS, and there are no exceptions. The third common time to exercise your stock options is upon an exit, such as an IPO or acquisition. This is the least risky time to exercise because you know the stock is liquid. Many taxpayers will use a financial advisor to help them develop the best tax strategy for their investments.

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While both are non-traditional forms of compensation, the two types of stock options work differently. Employees are more likely to receive NQSOs. If the value of the stock goes up, you have the ability to sell it for a profit.

14 Ways to Reduce Stock Option Taxes

Incentive stock options are similar to NQSOs but they include a special tax provision, discussed below, which makes them more attractive for employees. Executives or other high-ranking officials at a company are more likely to receive ISOs. Essentially, utilizing a DAF allows the charitable bunching strategy combined with the capability to give as you typically would.

The only downside is that you must have the ability to fund the account upfront, and the donation is irreversible. While our first three strategies covered reducing your tax bill today, our last planning strategy explores a way to hedge your RSU position and delay the sale—either because you need to maintain a position in your company stock or to delay the tax bill to a potentially more favorable year. A quick caveat—options can be risky and should be fully understood before implementing any strategy.

Additionally, like with anything, there is no free lunch. Hedging a position, even if generating income in the process, comes with tradeoffs. Under this strategy, call options are sold above the current price called out of the money. This generates income but caps your potential for gain with essentially all the risk of loss remaining.

Unlike the covered call strategy, a collar strategy does hedge the downside by buying a put. However, instead of just buying a put which is expensive , a call is also sold to offset some or all of the costs. In our example below, selling January calls and buying puts on Intel stock leads to a premium income of 1. The tradeoff is minimal income and a narrow range of potential outcomes. However, they could help you defer the sale of your RSUs until a more favorable time. RSU stock income is reported on your pay stub after vesting.

The value of your shares at vesting is taxed as income , and anything above this amount, if you continue to hold the shares, is taxed at capital gains. RSUs compensation is taxed at your ordinary income tax rate. If you choose to hold your shares after they vest, a ny gain or loss is taxed as a capital gain or loss. RSU income is tax ed when your shares vest. At vesting , RSU income is reported on your W2 , and any taxes withheld are included as well.

So, a RSU share is always at least as valuable as one stock option.


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However, because of this, companies typically grant more shares of options than RSU s. A rule of thumb for Technology employees is that four Options are roughly equivalent to one RSU share.

Stock option planning: Generating value

And optimizing your RSU strategy is one way to do just that. Whether you work with an advisor or not, make sure you understand and plan how you can make the most of this important form of compensation for those working the technology industry. And, if we can be of any help, please get in touch. Average rating 4. Vote count: 9.


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