AMT and Equity Compensation
Alternative minimum tax, nonqualified stock options, incentive stock options and other forms of equity compensation.
Unexercised NSO...what should I do?
Posted by: valifeisgood, October 26, 2015 07:32PM
Hello, I have 50,000 NSO shares of a privately held company; my Vesting Commencement date was 2007 and expiration of 2017. Exercise price is $0.10/share. Its a very explosive IT company which will likely see an IPO in next few years in excess of $20BB. Should I exercise the shares or hold them to before the expiration date? What kind of tax implications should I expect? Thank you.

Re: Unexercised NSO...what should I do?
Posted by: Kaye Thomas, November 9, 2015 12:06PM
From your description it seems there is a good chance these options will, if exercised before expiration, eventually produce a large profit for you. Nothing is certain in the world of IPOs, however.

You need to begin by understanding the total cost of exercising the option. The exercise price of $.10 per share, or a total of $5,000, is only part of the cost, because there may be a substantial tax cost as well. If the stock is currently valued at $1.10 per share, for example, you would also have to pay tax on $50,000. And you should be aware that the amount of tax required to be paid at the time of exercise is not always adequate to cover the entire tax cost, so you can owe additional tax when you file your return. The actual amount varies depending on your income level and the state tax, if any, that applies.

You will owe this tax even if you have no ability to sell these shares until after an IPO. Furthermore, you won't recover this tax if the company decides to stay private. In fact, even if the company fails and your shares become worthless the tax you'll recover is likely to be a small fraction of what you pay when you exercise the option.

Given the uncertainties of IPOs, the usual advice is to avoid exercising an option until after the IPO, or at least until the event has been scheduled and appears to be nearly certain to occur. An exception might be a situation where the tax cost is relatively low (usually shortly after the option was granted) and appears likely to grow substantially in connection with a forthcoming round of funding.

It appears your options may approach an expiration date before an IPO occurs. If so, you'll have to balance the potential reward of exercising, which may be great, against the overall risk that you'll be out of pocket for the exercise price and the tax cost for a period of time, and possibly even lose most of that money. That can be a tough choice, but it appears there is no need to make it now.

Kaye Thomas
Fairmark.com



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