How will the Trump-GOP tax reform affect stock options? The 2018 Tax Cut & Jobs Act may have negatively impacted taxes for employees in the top 2 venture-destinations, California and New York, but the overall changes were for the better. Alternative Minimum Tax (AMT) wasn't eliminated but then again the threat to tax options at vesting instead of exercise didn't pass either.
Qualified Incentive Stock Options (ISOs)
ISOs are still subject to AMT, but the following have a significant impact.
- The exemptions for AMT have been raised to $70,300 for tax payers filing as individuals or $109,400 for those filing as couples as of 2018 and to be adjusted over time based on inflation. This is good news for employees at successful startups because the higher exemption limits allow some of you to exercise more shares at your original grant prices without paying additional tax at the point of exercise.
- Another change is the increase in the phase-out thresholds when the exemptions do not apply. They are now $500,000 for individuals and $1 million for couples which is up substantially from $120,000 and $169,900 respectively for 2017.
- For Californians, changes are a mixed blessing because the capping of deductions for state and local taxes as well as home mortgage interest is painful but at least it is now much harder to trigger AMT.
Overall, the reduction of AMT makes it a lot easier to qualify for the lower Long Term Capital Gains Tax Rate by holding shares at least one year after exercising and at least 2 years after the original grant date. Previously, much of the LTCG benefit was negated by having to pay AMT on the spread between the original grant price and the current Fair Market Value (FMV). As such, LTCG benefits would mainly apply only to the additional rise in stock price after the exercise.
Since the Employee Stock Option Fund routinely advances cash equal to your AMT needs, the portion of the cash advance not needed for AMT can now be retained as taxable initial liquidity rather than being used entirely to pay AMT. Of course, if your base income is already subject to AMT and you need a large AMT advance as in the past, then ESO is still available to provide this for you if your application is approved. On the other hand, if you let ESO cover the cost of your exercise instead and skip the need for additional tax coverage, you will have a smaller total cash advance which results in lower repayment terms at final liquidity.
Non-Qualified Incentive Stock Options (NSOs)
NSOs are still subject to ordinary income tax at the point of exercise and there appears to only be small changes for the better.
- The highest bracket has been reduced to 37% which not only impacts NSOs in high income states but also reduces the short term capital gains rate to the same amount.
- The minimum withholding tax upon exercise has been reduced from 25% to 22%. This reduction can be dangerous in high income states like California where the majority of tech workers are almost certainly in tax brackets higher than 22%. Then again ESO can always fund your shortfall if you find yourself in a jam.
- The biggest change is now having the possibility of a section 83(i) election where you get a 5 year extension to pay the taxes.