AMT and Equity Compensation
Alternative minimum tax, nonqualified stock options, incentive stock options and other forms of equity compensation.
ISO and carry
Posted by: FR28, February 1, 2016 08:33PM
I have 1,000,000 incentive stock options in a privately held company with a market value per share of $5.00

My options have an exercise price of $1.00

I also have a carry over capital loss from previous stock trading of $500,000

I want to leave the company and need to exercise the options within 30 days.

there is no IPO or liquidation event currently planned although one may present itself in the future.

how much cash do I need to exercise my stock options? does my $500,000 carry over loss reduce my tax bill associated with exercising my stock options?

what taxes can I expect to incur as a result of exercising my stock options?

any other thoughts on my situation?

Re: ISO and carry
Posted by: triad, February 1, 2016 10:07PM
In order for this to work they way you expect, you need to exercise the ISOs and sell them before 12/31 of the same year.

If you exercise and do not sell, the schedule D would not be affected and the spread is added to the AMT form and triggers a tax bill and credit. If you have no other sales of capital assets, your $500K carry forward would be limited to a $3000 loss and the $497K continues to 2017.

If you exercise and sell 125,000 shares at $5 before 12/31/2016, you would have a $500,000 gain for schedule D which when combined with the carry forward works out to $0 and $0 to carry forward to 2017. If you exercise the remaining 875,000 shares but do not sell, you put that portion on the 6251 and that $3.5M will trigger a lot of AMT tax.

If you can't readily sell the stock, why create an AMT nightmare?

Re: ISO and carry
Posted by: FR28, February 1, 2016 10:21PM
Want to pursue another opportunity at another company with more equity and salary compensation and must exercise options within 30 days. So there is no way to take advantage of that 500k capital loss carryover through this process?

Re: ISO and carry
Posted by: Kaye Thomas, February 1, 2016 11:22PM
You won't be able to use the capital loss carryover, regardless of whether you hold shares or sell them. Selling shares before the end of the year would produce ordinary income, not capital gain, so there would be no capital gain against which to use the capital loss.

This is a tough situation because if that $5 valuation is genuine, you have $4 million in profit but will either have to walk away from it or pay a lot of tax with the possibility you won't be able to cash in until long after the tax falls due. Basically you're looking at paying $1.00 in exercise price and $1.12 in federal AMT for every share you exercise. If you're in California, add another $0.28 in California AMT. Exercising the entire option would require a total outlay of $2.12 million or $2.4 million, depending on whether you have the privilege of paying California tax.

Even if you have a way to raise the money, this is a big gamble on being able to eventually cash in. Otherwise there's the little problem of having to walk away from $4 million in option profit, and potentially plenty more to come if the company succeeds in producing a liquidity event.

Kaye Thomas

Re: ISO and carry
Posted by: FR28, February 2, 2016 02:27PM
these 1,000,000 options are ISO.

if I do I have the cash to exercise the options and choose to do so in 2016 with the expectation that I will not an ability to sell the shares until 2017 or 2018, would you say that my expected AMT tax rate is 28% for 2016? when would that be due? April 2017?

is there any situation where the ISO (favorable tax status) is in jeopardy if I were to exercise all 1,000,000 options in 2016? if, so, how would that impact my tax rate if at all?

Re: ISO and carry
Posted by: triad, February 2, 2016 08:25PM
Kaye, if the stock option grants were two or more years ago, he'll have met the holding requirement for ISOs and it would be capital gain.

Grants that are less than 2 years old would be ordinary.

Re: ISO and carry
Posted by: Kaye Thomas, February 2, 2016 09:02PM
FR28, assuming these are all ISO, the expected AMT rate would be 28%, and if the option is exercised in 2016 the tax would be due April 2017 even if you have no way of selling the shares at that time.

There is no limit on the number or value of ISO that can be exercised in a single year. However, your question woke me up to a likely issue given the facts you've presented. There is a $100,000 limit on the value of ISO that become exercisable in any given year. For this purpose, value is usually the same as exercise price. This means your option exceeds the limit, because it surely did not vest (become exercisable) over a period of ten years. Assuming a typical four-year vesting period, the 250,000 shares vesting each year would be 100,000 ISO and 150,000 nonqualified options, even if your documentation describes the entire grant as ISO. This would not affect the total amount of federal income tax you pay in the year you exercise the option, but it would require you to pay Medicare tax on a large chunk of this paper profit, and you would have to pony up a lot of the tax at the time you exercise the option rather than next April.

Triad, the issue here is how much tax would be paid upon exercise of the option, which is determined under the AMT rules, where the option is treated the same as a nonqualified option and there is no opportunity to treat the profit that's built-in at the time of exercise as capital gain.

Kaye Thomas

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