Holders of non-qualified stock options (NSOs) are subject to tax at exercise if the fair market value of the stock is higher than the exercise price (“spread”). If you leave a company and negotiate an extension on your exercise period that is longer than 90 days, then your ISOs will become non-qualified stock options. NSOs are more typically associated with non-employees such as contractors and outside business partners. Moreover, employers are required to withhold at least 25% of the spread at the time of the NSO exercise. This withholding includes federal, medicare, FICA, and applicable state income taxes.
Since the cost of exercising stock options is already very high, the addition of taxes makes the entire investment even more risky. A solution for reducing this risk is obtaining an advance from the ESO Fund to cover the entire cost of exercising your stock options, including the tax. You retain unlimited upside potential without risking any of your personal capital. If you exercised your ISO stock options earlier this year and are concerned with the tax burden next year, then ESO is an ideal solution since we can provide money for the AMT and for the cost of the original exercise. If the ESO transaction occurs during the same tax year you exercise your ISOs, there could be a substantial tax savings. Another benefit of using ESO proceeds to pay AMT is having AMT credits for subsequent years when you are not subject to AMT. This is a very common result because many people only trigger AMT during the year in which they exercise a large block of stock options. Similarly, letting ESO pay your withholding taxes on an NSO exercise has the indirect benefit of reducing your AMT liability.
You retain title to the stock in an ESO transaction. You also retain the ability to pay off ESO at any time before the company exits. For more information regarding how ESO can benefit you, please contact us.
How to Calculate Alternative Minimum Tax (AMT)
First calculate your tax without the ISO exercise. You can use an online program such as www.turbotax.com for free as long as you don’t file the return. If you use Turbo Tax, there will be a question similar to, “Did you exercise and hold Incentive Stock Options During the Tax Year?” You should answer “No” to this question for now. Now take the following steps:
- Note your total tax amount $ for both state and federal. This is your baseline tax.
- Now enter an ISO exercise by going back to the question where you initially said No. This time say Yes.
- Enter the number of shares, exercise price, and Fair Market Value at the time of the exercise. Normally, you would be entering this information from IRS Form 3921 which your company would have sent you in January of the year following your exercise.
- Upon submitting that ISO exercise event, your total taxes for both Federal and State should immediately update.
- The difference, if any, between this updated tax figure and your baseline taxes noted earlier is the AMT associated with your ISO exercise.
- Let your ESO account manager know this figure if you want ESO to include this amount in your cash advance.
Note that tax rates can change between the time you do this exercise and the time you actually file your return. Moreover, many other factors such as deductions, your tax bracket, state income taxes, and capital gains will also impact your final AMT calculation. Since the ESO Fund has no way of knowing how your final taxes will look, you are advised to work with a tax professional to minimize your risk of not having sufficient funds when you finally file your tax return. The ESO Fund is not obligated to increase its cash advance to you at a later date.