A potentially huge tax savings available to founders and early employees is being able to exempt up to $10 million in capital gains or 10x the invested capital, whichever is greater, from federal taxes if the investment was held at least 5 years. Exercising stock options from an eligible company counts as investing! The rules applying to Qualified Small Business Stock (QSBS) were designed to encourage investments in certain small businesses.The exemption no longer applies to California income taxes since 2012 However, the exemption no longer applies to California income taxes since 2012. Some entrepreneurs contemplate leaving California before their M&A or IPOs are completed, but be warned that this must be a bonafide intention to move and is subject to audit for at least 3 years. Other states should be reviewed on a case by case basis.
The main factors to qualify for QSBS status are:
- The stock has to be purchased directly from the company as opposed to a secondary market.
- The company needs to be a C corporation.
- The stock had to be issued after August 10, 1993.
- Company issuing the stock has had less than $50 million in total assets continuously from inception or August 10, 1993 through the point where the investment was made.
- Certain redemptions can retroactively eliminate QSBS status.
- Many service businesses, hotels, banks, insurance companies, farms, etc. are not eligible for QSBS treatment.
- If you have not yet met the 5 year threshold, you can do a qualified rollover into another QSBS until the 5 years has been achieved.
For professional tax assistance on your QSBS situation, feel free to contact Leung, Louie, IP & Co. LLP.
Qualified Incentive Stock Options (ISOs) are not subject to ordinary income tax when exercised but are subject to Alternative Minimum Tax. Most people are not subject to AMT, so you can use our AMT calculator method to determine just how many shares you can exercise each year before tripping the AMT threshold. The basic idea is to set up your tax program to calculate your likely taxes for this year except indicate that you only exercised one share. You'll You also have the benefit of avoiding larger amounts of AMT that would otherwise be dueneed to know the current Fair Market Value (FMV) of your shares in order for the software to calculate your tax impact. Then go back and change that 1 share to 2 shares and see if your tax increases. If not, then you aren't subject to AMT at all. If it goes up right away, then you are subject to AMT based on your base income regardless of how many shares you exercise. But if not, then gradually increase the number of shares you exercise until your taxes due/refund finally changes. That will be the threshold where you first trip AMT, so you can exercise up to that many of your ISO shares without tax consequences and thereby get a head start on your eligibility for long term capital gains treatment. You also have the benefit of avoiding larger amounts of AMT that would otherwise be due if you were to exercise these shares later on when the current FMV of your shares is higher.
If you can't afford the cost or bear the risk of exercising your shares, you can contact us at the Employee Stock Option Fund for a non-recourse cash advance against those shares. If those shares turn out to not be a good investment, ESO bears the loss as opposed to you. Visit this page for more ideas on how to save money on stock option taxes.
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