At a liquidity event such as an M&A, unexercised stock option grants are typically cashed out for a value equal to the spread between the exercise price and the liquidity price per share net to common stockholders. When the company executes such a payout, it is considered a compensation event and subject to payroll taxes. This includes both the employee’s medicare tax and the employer’s payroll taxes.When the company executes such a payout, it is considered a compensation event and subject to payroll taxes. However, if the ISO grant is exercised before the M&A event you can avoid ISO payroll taxes. In this case, the final profits are either a disqualifying disposition or a capital gains event depending on how much time has elapsed between the exercise and the M&A event. Nevertheless, both cases are investment income related and will not be subject to the 3.8% Net Investment Interest Tax. The exception being very high income individuals where the surtax is reinstated on investment income.

Something similar is true if you hold Non-qualified Stock Option grants (NSOs). You'll pay medicare taxes on the spread between your exercise price and the FMV at the time of your exercise, but the final gain between the FMV and ultimate exit price is considered a capital gain. That is generally not subject to medicare taxes except for the surtax and to the extent that it places you in a higher tax bracket. If it turns out to be a long term capital gain, then there will be additional savings.

If you hold employee stock options or restricted shares in a private company funded by institutional venture capital, feel free to contact us at the Employee Stock Option Fund for more information on how we can assist you with a non-recourse cash advance. By doing so, you can not only avoid the risks associated with investing directly in a startup but possibly improve your taxes as well. For ways to reduce stock option taxes and specific tax related support related to stock option exercises, please contact Scott Chou.

If you hold ISOs and your company is acquired, then you may trigger the 100K Limit Rule if your option agreement has an acceleration feature. Suddenly vesting all or more of your unvested options will increase the total number of options you vest for the year. Although your original grant was designed to stay under the 100K Limit, you may suddenly exceed it unintentionally.  As a result, some of your ISOs will be NSOs are more expensive since they are subject to ordinary income tax including the Medicare surtaxes.converted to NSOs in order for you to stay compliant. NSOs are more expensive since they are subject to ordinary income tax including the Medicare surtaxes.

On the other hand, if you exercised some of your ISOs in advance, then the number of shares exceeding the 100K Limit due to acceleration will be reduced. Moreover, you could also be eligible for long term capital gains or at least avoid the Medicare surtax. The exception would be high income individuals where the 3.8% Net Investment Interest Tax is reinstated.

If you hold employee stock options or restricted shares in a private company funded by institutional venture capital, feel free to contact us at the Employee Stock Option Fund for more information on how we can assist you with a non-recourse cash advance. By doing so, you can not only avoid the risks associated with investing directly in a startup but possibly improve your taxes as well. For ways to reduce stock option taxes or specific tax related support related to stock option exercises, please contact Scott Chou.