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 and social security taxes as well as the employer’s matching portions.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 on not only the exercise but the final profit as well. 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. The exception being very high income individuals where the 0.9% surtax is reinstated on investment income.

However, this only applies to ISOs and not NSOs.  Exercising NSOs early less than a year from the exit event might actually worsen your taxes. 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. Capital gains aren't compensation income so your employer won't pay the matching payroll taxes which leaves you to pay medicare taxes of 2.9% including the possible surtax of 0.9% for high income situations.

If the liquidity event is an IPO, an ISO exercise followed by a sale that occurs the same year is also a disqualifying disposition.  Such a sale is free from medicare and social security taxes. Moreover, you have control over the timing of the sale until December 31st which gives you time to locate other potential savings such as rollovers or moving to a less expensive tax jurisdiction. If you keep the shares at least a year from the exercise date and 2 years from the grant date, you'll be eligible for the reduced long term capital gains but you'll be subject to AMT for the year of the exercise. Even if you don't qualify for LTCG, selling after December 31st brings on short term capital gains income which can be offset by any capital losses available that same tax year.

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 a disqualifying disposition which avoids the Medicare surtax.

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.