ISO sale and long term capital gain (2)

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    (Reposting because I don’t think the original went through, the website doesn’t show it)


    I read the whole section on ISO on the website but I don’t think it covers my specific question.

    This is my situation, at a small startup:

    – I exercised my vested ISO (paying 6 figures AMT) in a previous year

    – Last year (so 1+ years after the exercise, and 2+ years after the grant), I sold some in a secondary transaction that the company offered (it was not targeted at all employees, just to a very small group): the key here is that the company bought my shares for ~3X the 409a FMV at the time of the transaction, essentially at a price much closer to the last preferred shares valuation (even though mine are just common shares).

    – The company never did any reporting on my W-2, and never issued a 1099-B, or any other additional documentation except the original share buyback contract signed by both parties, essentially leaving me on my own. Following what I learned from studying the rules, and also guided by my tax software interview questions, I reported the whole transaction as long term capital gain, on the whole spread SALE_PRICE – COST_BASIS, completely ignoring the FMV at the time of the transaction.

    – Clearly for AMT purposes I adjusted the cost basis to include the FMV at the time of the exercise, on which I paid AMT tax previously (all consistent with the form 3921 I received and used for AMT calculation in prior years).

    My question is: what I did seems normal, however, reading comments of a few other people online in this situation, they said that this case is special, and the company should have reported some portion of the proceeds as compensation, specifically the SALE_PRICE – FMV_AT_SALE_TIME portion, since they paid a price much higher than the FMV at sale time. According to them, the long term capital gain treatment should just be claimed on the portion of the proceeds that are within the 409A FMV at sale time, specifically FMV_AT_SALE_TIME – COST_BASIS.

    Does this make any sense?



    Kaye Thomas

    There is a general principle in taxation that says a transaction is to be taxed in accordance with its economic reality. The facts you recite may seem to suggest the company paid an inflated price for the shares as a way to provide you with additional compensation for services. Yet the reality could be different. It’s possible the company had some strong reason for wanting to redeem these shares, and made the offer at a price that would be hard to refuse. In any event there is no hard and fast rule that any amount paid above the 409A value must be treated as compensation.

    In fact, depending on how they viewed the facts and circumstances, the IRS might object if the company treated part of the amount paid as compensation. That treatment would result in higher tax for you, but would also convert a nondeductible stock purchase expenditure into deductible compensation on the company’s tax return.



    Thank you very much for your explanation, greatly appreciated.

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