AMT and Equity Compensation
Alternative minimum tax, nonqualified stock options, incentive stock options and other forms of equity compensation.
Vested ISO exercise and 83(b). What is FMV?
Posted by: Tax_curious, February 8, 2015 05:20AM
I have some questions on ISO stock options:


A) The stock options can only be exercised once vested. The vesting schedule is the typical 1-year cliff and then monthly for the remainder. In this case when I exercise them should I be completing a 83(b)? Or is this only done for ISOs that are exercised prior to being vested?

B) I assume that when I exercise them I will need to pay AMT income tax on the delta between the FMV and the exercise price (but nothing under regular tax) but if I hold them for at least 1 additional year before selling them they will be treated as Long term capital gains (netted against the AMT income tax). Does this sound right?

C). How is the FMV at the time of exercise determined? We have a 409(a) that is about 9 months old based on our last financing. The company is currently going thru a new financing round (term sheet signed) and expected to close in a few weeks at a new valuation. Assuming I exercised today would we use the old 409(a) valuation which is most recent and known? A new 409(a) valuation will likely take months after the new round of financing to be completed, but the effective date may take effect to the term sheet signing. Could I exercise ISO options without knowing what the FMV is if a new 409a is not available?

Re: Vested ISO exercise and 83(b). What is FMV?
Posted by: Kaye Thomas, February 9, 2015 02:35PM
A) The purpose of the 83b election is to treat stock as being vested even when it isn't vested. It has no relevance to stock that is vested.

B) Your description of the tax consequences is heading in the right direction but not fully accurate. Your tax on sale of the stock will not necessarily be fully offset by the AMT you pay for the year of exercise. In particular, there is no offset for net investment income tax or for any capital gain resulting from an increase in the value of the shares occurring after you exercise the option.

C) There's nothing in the tax rules that would answer the question of how to determine fair market value in a situation like this (it depends on "facts and circumstances"). You need to ask the company what value they'll use for tax reporting purposes. Although it's theoretically possible for you (or the IRS) to use a value different from the company's reported value, I've never seen this happen.

Kaye Thomas
Fairmark.com

Re: Vested ISO exercise and 83(b). What is FMV?
Posted by: Tax_curious, February 10, 2015 04:37AM
Thanks for the response.

I'm a little confused on your response B)

I understand no offset on the investment income tax. But isn't my cost basis higher under AMT when I eventually sell the stock, so in the future (ASSUMING THE STOCK GOES UP - I UNDERSTAND THIS MAY NOT HAPPEN - BUT FOR SAKE OF THIS SCENARIO LET'S ASSUME IT DOES) when I sell the stock my AMT tax will be lower than my regular tax, and I would be able to use my AMT credit against my regular tax?

Perhaps "offset" is the wrong word to use, but rather my AMT credit can be used in the future to reduce capital gains.

Re: Vested ISO exercise and 83(b). What is FMV?
Posted by: Kaye Thomas, February 11, 2015 03:36AM
Simplified example: Suppose you have $100,000 profit built in when you exercise and pay $28,000 AMT. If you sell a year later and the profit is still $100,000 (stock price unchanged), your regular tax capital gain tax is $20,000 and AMT capital gain tax is zero so you recover $20,000 AMT credit for zero tax cost. If instead the stock goes up so that your profit at sale is $150,000, your regular tax capital gain tax is $30,000 and your AMT capital gain tax is $10,000, so once again you recover $20,000 AMT credit and have $10,000 tax cost. You don't recover the entire $28,000, even though you have $30,000 regular tax cost on the sale, because in this scenario you have a $50,000 capital gain for AMT purposes.

Kaye Thomas
Fairmark.com



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