Reply To: Stock Options- When to Exercise

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Kaye Thomas

An author is always gratified when someone buys his book, and much more so on the rare occasions when he learns someone has actually read it. But multiple reads? Thats almost scary.

I was able to be more definitive in my discussion of NQSOs because the situation there is relatively simple. The analysis becomes much more difficult for ISOs, especially pre-IPO.

Answers depend in part on which of three categories we’re dealing with. In some cases, the bargain element is small enough to fly under the AMT radar, or at least allow us to anticipate full recovery of the AMT credit in the year of sale or shortly thereafter. Some folks have such a large bargain element that the AMT exemption amount, normally a key part of the analysis, becomes an insignificant detail in the planning. Cases that fall between these extremes are the most complicated to plan.

Pre-IPO situations are more difficult. Shares usually cannot be sold to cover costs of exercising, including any tax cost, or to accomplish ISO balancing (where anticipated AMT credit recovery matches AMT incurred). They also entail greater financial risk, as many a sure thing has turned into a painful reversal.

So I can’t offer much in the way of rules of thumb here. One strategy to consider is partial exercise each year to the level where AMT begins to apply, to maximize use of the AMT exemption amount. I don’t think my book says much about this idea because it was written at a time when few taxpayers could gain any significant benefit. Recent changes in AMT and other tax rules may make it worth considering.

Beyond that, you need to sharpen your pencil, or rather, your spreadsheet skills, and try some scenarios, always bearing in mind investment risk and the dismaying frequency with which the tax laws change.