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Tax Consequences when Exercising Stock Options

The Alternative Minimum Tax (AMT) can apply to current and former employees of privately held companies when they exercise their incentive stock options (ISOs) if the fair market value is higher than the exercise price. The AMT can have a significant cash impact on those who exercise their ISOs.

Holders of non-qualified stock options (NSOs) are subject to tax at exercise if the fair market value of the stock is higher than the exercise price ("spread"). If you leave a company and negotiate an extension on your exercise period that is longer than 90 days after your final day of employment, then your ISOs will become non-qualified stock options. NSOs are more typically associated with non-employees such as contractors and outside business partners. Moreover, employers are required to withhold at least 25% of the spread at the time of the exercise. This withholding includes federal, medicare, FICA, and applicable state income taxes.

Since the cost of exercising stock options could already be very high, the addition of taxes makes the entire investment even more risky. A solution for reducing this risk is obtaining an advance from the ESO Fund to cover the entire cost of exercising your stock options, including the tax. An indirect benefit of letting ESO finance your option exercise is the possibility of taking disqualifying disposition that can eliminate much if not all of the AMT and reduce your near term tax liability. Conceptually, ESO is making installment payments towards purchasing your stock with the final payment occuring after the stock becomes liquid and transferrable. The initial payments are typically the cost of exercise and taxes and the final payment will be a function of the final value at that time. In effect, you retain unlimited upside potential without risking any of your personal capital. If you exercised your ISO stock options earlier this year and are concerned with the tax burden next year, then ESO is an ideal solution since the AMT problem is solved AND your cost of the original exercise is also refunded to you. The main requirement is that your ESO transaction must occur during the same tax year in order to qualify for an AMT disqualifying disposition. Even if you don't elect to take an AMT Disqualifying Disposition, potential benefit of using ESO proceeds to pay AMT is having AMT credits for subsequent years when you are not subject to AMT. This is a very common result because many people only trigger AMT during the year in which they exercise a large block of stock options.

No transfer of stock is required under ESO's program unless and until there is a liquidity event involving the company that issued the shares, such as a sale or IPO. Prior to that, you also retain the ability to pay off ESO at any time and avoid the final transfer of shares. For more information regarding how ESO can benefit you, please contact us at the ESO Fund.

How to Calculate Alternative Minimum Tax (AMT) as of 2016

First calculate your tax the regular way. Add the following together:

  • Regular taxable income
  • plus Disallowed deductions (medical, state and local tax, etc.)
  • plus Personal exemptions
  • plus ISO spread (fair market value at the time of exercise less exercise price)
  • less ($53900, $83800, $41700) AMT standard exemption when filing: Single, Married, or Married filing separately

The sum of the above items equates to your AMT taxable income. Then calculate the AMT by multiplying by 26% the income amount up to $186,300 ($93,150 married filing separate) plus 28% of the amount over $186,300. Then be aware of the complete phase out threshold where you don't even get the standard exemption. The threshold is $119,700 for Single filers, $159,700 for Married filing Jointly, and $79,450 for Married filing Separately. So you now pay the IRS the greater of your regular tax or the AMT.

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The ESO Fund does not provide legal, financial or tax advice. The above transaction description is a general description only and all terms are subject to final documentation between ESO and cash advance recipient.