Resources

Exercising, Taxes & Accounting

Exercising

The amount needed to exercise your stock options is equal to the number of options multiplied by the exercise price. For example, if you have 1,000 options with an exercise price of $1 it will cost you $1,000 to exercise.

Nowadays most companies use online equity portals such as Carta for everything from housing documents to tracking value and exercising. If your company does not use an equity portal, you will likely need to contact the stock controller or HR for instructions on exercise, which typically includes filling out an option exercise form and submitting payment either via check or bank wire. Once exercised, options turn into shares and you become a partial owner of the company.

Taxes

Employee Stock Options are not taxable when granted (Except for RSUs which are taxed differently). ESO taxation begins when the options are exercised, and taxes are calculated based on the spread between the current Fair Market Value (FMV) and the exercise price. As mentioned earlier you are taxed differently depending on what type of options you own, however the way taxes are calculated, and the cost of exercising remains the same.

Based on the prior example (1,000 options with an exercise price of $1):

If the current FMV is $2 your taxable income will be $2 - $1 = $1 per share, thus your taxes will be based on $1,000 of income (then adjusted depending on the applicable tax rate). It is easy to see how exercising of options can charge a hefty price, thus why it often makes sense to exercise your options with The Employee Stock Option Fund to preserve your cash and avoid unnecessary personal risk.

Employee stock options are also taxed upon sale. If the sale occurs within 1 year of exercise, they are taxed as short-term capital gains (ISOs sold within a year of exercise will not be subject to AMT). Any sale taking place beyond one year of exercise is subject to the lower long-term capital gains rate. Sales could include secondary market sales, company buybacks, or post IPO/M&A sale of the stock.

Accounting

When exercising an ISO, you will receive a Form 3921 “Exercise of an Incentive Stock Option” from your employer which will contain the information required to report your taxes associated with the exercise. When exercising NSOs, you will report this as ordinary income on your W-2 Form. When exercising NSOs or settling RSUs employees may elect to defer recognition of income for tax purposes for up to 5 years by filing an 83(i) Election.

At the sale of any shares you own, you will receive a Form 3922 “Transfer of Stock Acquired Through an Employee Stock Purchase Plan” from the company which will outline your gain/loss as well as whether the income is considered capital gains or ordinary income.

Overall, given the complex taxes associated with your employee stock options, it is advised to consult with your tax advisor about how you will be affected.

When working for a privately held company, all these taxes and exercise costs bring up the important question of when to exercise. While there is usually no simple answer given the risky nature of the asset, there are some scenarios you should be aware of prior to deciding.

For more information on how to monetize your private company equity, please contact us at the Employee Stock Option Fund.

This innovative service promotes and enables a healthier relationship between companies and employees. I my opinion it's valuable to employees and great for the overall tech environment and economy. It is good for nobody when employees feel trapped because they can't afford to leave. In less extreme cases exercising can be expensive and somewhat risky and this is simply a good smart hedge and a good square deal. Brilliant!

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