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Net Exercising Your Stock Options

Net exercising is essentially a  cashless exercise where you tally up the total net value of your stock options based on the number of vested shares multiplied by the spread between the current Fair Market Value (FMV) and your exercise price(s). That total value is then divided by the current FMV to determine how many shares you get. This total value is then taxable to you at ordinary income tax rates. Since your stock isn't actually liquid yet, the tax obligation from a cashless exercise can be quite burdensome.

Private companies rarely offer a cashless exercise feature because the stock options were meant to be a retention tool, but A cashless exercise makes it easy for employees to leave the companya cashless exercise makes it easy for employees to leave the company without abandoning their option grants. When they do offer it, it is usually available only after liquidity is available for the stock to address the associated taxes. If the feature isn’t explicitly listed as a feature of your option grant, then attempting to simulate it by selling shares and buying shares could cause double taxation. First you exercise the options which triggers taxes. Then you sell the shares which triggers more taxes. Whatever money is left can be used to exercise more shares that you keep. But that final exercise triggers taxes, too. This sequence of repeated taxation is usually a disaster. A much more efficient tax solution is available by obtaining non-recourse financing from the ESO Fund.

Cash for Your Escrow Payments

Do you need cash for your escrow payments? Were you a shareholder of a venture backed company and will receive future sales proceeds from an escrow release and want cash now?

We pay cash for your right to receive your escrow (future sale proceeds) payments.

Why take the risk that the escrow may never pay off or wait for years to get paid?When a company sells itself, shareholders typically receive an upfront payment and there are often future sales proceeds that are held in escrow and released in the future.

These escrow payments may never be made — they depend on whether the purchasing company has any claims against the selling company.

Why take the risk that the escrow may never pay off or wait for years to get paid, if you get anything at all. We’ll pay you cash now for your rights to the escrow payments. No strings attached. If the escrow doesn’t pay off, we take the loss.

If you want more information, email us at escrow@esofund.com and let us know:

  • The company you owned stock in
  • How much you estimate your escrow proceeds will be
  • The release dates of the escrow
  • The name of the payment agent (e.g., SRS Acquiom)

How Will the 2018 Tax Reform Affect Your Stock Options?

How will the Trump-GOP tax reform affect stock options? The 2018 Tax Cut & Jobs Act may have negatively impacted taxes for employees in the top 2 venture-destinations, California and New York, but the overall changes were for the better. Alternative Minimum Tax (AMT) wasn't eliminated but then again the threat to tax options at vesting instead of exercise didn't pass either.

Qualified Incentive Stock Options (ISOs)

ISOs are still subject to AMT, but the following have a significant impact.


  1. The exemptions for AMT have been raised to $70,300 for tax payers filing as individuals or $109,400 for those filing as couples as of 2018 and to be adjusted over time based on inflation. This is good news for employees at successful startups because the higher exemption limits allow some of you to exercise more shares at your original grant prices without paying additional tax at the point of exercise.
  2. Another change is the increase in the phase-out thresholds when the exemptions do not apply. They are now $500,000 for individuals and $1 million for couples which is up substantially from $120,000 and $169,900 respectively for 2017.
  3. For Californians, changes are a mixed blessing because the capping of deductions for state and local taxes as well as home mortgage interest is painful but at least it is now much harder to trigger AMT.

The reduction of AMT makes it a lot easier to qualify for the lower Long Term Capital Gains Tax RateOverall, the reduction of AMT makes it a lot easier to qualify for the lower Long Term Capital Gains Tax Rate by holding shares at least one year after exercising and at least 2 years after the original grant date. Previously, much of the LTCG benefit was negated by having to pay AMT on the spread between the original grant price and the current Fair Market Value (FMV). As such, LTCG benefits would mainly apply only to the additional rise in stock price after the exercise.

Since the Employee Stock Option Fund routinely advances cash equal to your AMT needs, the portion of the cash advance not needed for AMT can now be retained as taxable initial liquidity rather than being used entirely to pay AMT. Of course, if your base income is already subject to AMT and you need a large AMT advance as in the past, then ESO is still available to provide this for you if your application is approved. On the other hand, if you let ESO cover the cost of your exercise instead and skip the need for additional tax coverage, you will have a smaller total cash advance which results in lower repayment terms at final liquidity.

Non-Qualified Stock Options (NSOs)

NSOs are still subject to ordinary income tax at the point of exercise and there appears to only be small changes for the better.


  1. The highest bracket has been reduced to 37% which not only impacts NSOs in high income states but also reduces the short term capital gains rate to the same amount.
  2. The minimum withholding tax upon exercise has been reduced from 25% to 22%. This reduction can be dangerous in high income states like California where the majority of tech workers are almost certainly in tax brackets higher than 22%. Then again ESO can always fund your shortfall if you find yourself in a jam.
  3. The biggest change is now having the possibility of a section 83(i) election where you get a 5 year extension to pay the taxes.

See this link for more information on differences between ISOs and NSOs. See this link for other ideas on how to reduce taxes on your stock options. For questions and assistance obtaining financing, please contact Scott Chou at the Employee Stock Option Fund.

© 2012-2018 ESO Fund. All Rights Reserved. The ESO Fund does not provide legal, financial, or tax advice.

Avoid ISO Payroll Taxes

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.

 

Avoid Triggering $100K Limit on an M&A

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.

Differences ISO vs. NSO

The main differences between ISOs and NSOs all have to do with taxes:

1. Definition

More formally known as Qualified Incentive Stock Options (ISOs) and Non-qualified Stock Options (NSOs or NQSOs). The qualification refers to eligibility for special tax treatment.

2. AMT or Ordinary Income Tax

When you exercise either stock option, there is a spread between the exercise price and the current Fair Market Value (FMV) that is subject to Tax ISOs receive special tax treatment and are exempted from ordinary income tax on the spread. However, exercising an ISO is subject to Alternative Minimum Tax (AMT), which comes into play for wealthier tax payers or when the spread is large. NSOs are subject to the higher ordinary income tax rate on the spread. Individuals who are in an ordinary income tax bracket lower than the AMT rate are inherently not subject to AMT.

3. Expiration

ISOs only apply while you are still employed at the company that issued the grant and cannot be extended beyond 90 days after you leave. NSOs don’t require employment and can be extended well beyond 90 days. Moreover, ISO grants can only last 10 years before they must be exercised regardless of whether the holder is still employed at the company.

4. When Taxes are Due

A major difference is that the NSO tax is withheld at the point of exercise whereas the potential AMT on ISOs isn’t due until you file taxes next April. You won’t know if you are even subject to AMT until after your taxes have been calculated. However, the disqualifying disposition of the ISOs by selling during the same tax year as the exercise will trigger ordinary income tax, which is required to be serviced by quarterly estimated tax payments. NSOs do have the possibility of an IRS Section 83(i) election where you can defer taxes for 5 years.

5. Withholding Taxes

The minimum NSO exercise withholding requirement is only 22% for up to $1 million in spread value (37% if over $1 million). Many companies try to estimate the right amount but it isn’t very easy. Companies are required to withhold NSO taxes for employees, but contractors can be given a 1099 instead, which means they handle their own payments via quarterly estimated taxes. Regardless of whether the company withholds taxes or you make estimated payments, you will true it up to the required amount when you actually file taxes. That could result in a refund or additional taxes. Even lottery winners are surprised that they often owe more taxes despite the mandatory withholding at the beginning. If you sold ISO shares, you are also responsible for paying quarterly estimated taxes which you calculate yourself. If you don’t pay enough, there are interest penalties when you file next April.

6. Disqualifying Disposition

If the ISOs are sold during the same tax year as the exercise, then you will pay ordinary income tax on the spread between the exercise price and the actual sale price. This will be a disqualifying disposition and you will no longer be subject to AMT on the spread between the exercise price and the FMV. If you sell shares resulting from an ISO after the year of exercise but within a year of exercise or within 2 years of the grant, it is also a disqualifying disposition subject to OIT but you are still on the hook for AMT in the tax year of the exercise. This another form of Double Taxation.

7. Double Taxation

If you sell ISOs after the tax year of the exercise, then you will be subject to AMT for the year of the exercise AND be subject to capital gains tax and/or ordinary income tax on the profits from the sale for that subsequent tax year. Those taxes are calculated based on the spread between the final sale price and the exercise price and the FMV at the time of exercise even if you have already paid AMT on the spread between the FMV and the exercise price. Recovering the AMT via credits on an ordinary income tax return could take a long time unless you are subject to AMT every year anyway. If you are subject to AMT in the year of the sale and paid AMT during the year of the exercise, you are eligible to use the FMV at the time of the exercise as your cost basis instead of the lower exercise price. This helps you avoid double taxation on ISOs.

8. Qualifying Dispositions and Capital Gains Tax

When shares resulting from an ISO are sold at least 1 year after the exercise and 2 years from the grant date, then the sale qualifies for long term capital gains treatment on the spread between the exercise price and the final sale price. When ISOs are sold in a disqualifying disposition, then ordinary income tax is paid on the spread between the final sale price and the exercise price. NSOs are similar when sold within a year of exercising. For NSOs, ordinary income tax was paid on the original exercise but short term capital gains was paid on the spread between the final sale price and the FMV at the time of exercise. Since the STCG rate is currently the same as the ordinary income tax rate, it is almost a wash with selling ISOs except that short term capital gains on the portion of the income above the FMV from the sale of NSOs can be offset by other capital losses you may have that tax year. There is no similar offset for the ordinary income tax gains from selling your ISOs.

9. Medicare Taxes

Another subtle difference involves Medicare taxes. Medicare taxes are charged on NSO exercises but not on the ordinary income tax associated with ISO disqualifying dispositions. Capital gains income tax, both short term and long term, are also not subject to Medicare taxes. The exception would be the Medicare Additional Tax which is reinstated for all the high income tax brackets or for when the final capital gains income is large. In general, the lack of Medicare tax for lower gains is an intrinsic advantage of ISOs over NSOs.

10. Reducing AMT

If you exercised the NSOs and paid the proper amount of taxes, your Alternative Minimum Tax (AMT) on any ISOs exercised the same year goes down. This makes your overall optimization challenge to be a good spreadsheet problem. This last scenario means that in a given year, you may want to exercise and sell NSOs and use the money to exercise ISOs for long term capital gains eligibility because the AMT will be lower or zero. Rather than losing all future benefits from the NSOs sold, many ESO clients leverage the Employee Stock Option Fund to exercise the expensive NSOs and cover the taxes while they exercise the less expensive ISOs on their own.

11. 100K Limit

Because of their favorable tax treatment for most people, the amount of ISOs eligible for exercise each year is limited to $100,000. This is calculated by multiplying the number of shares eligible for exercise in any given year by the exercise price. This limit causes larger grants to be split into ISOs and NSOs. Individuals who have both should consider item (10) to maximize their benefits.

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 ways to reduce stock option taxes or more information on how we can assist you. 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 specific tax related support related to stock option exercises, please contact Scott Chou.

Reduce AMT Exercising NSOs

Alternative Minimum Tax (AMT) was designed to ensure that tax payers with access to favorable tax shelters pay at least a minimum amount of tax. The AMT rate is lower than the ordinary income tax rate applicable to the same level of income since it is considered a minimum amount. The calculation of AMT is based on calculating your taxes two ways and paying the higher figure. If the AMT calculation is higher, then the difference of the AMT method over the ordinary method is your Alternative Minimum Tax. A natural consequence of exercising NSO shares that require immediate Alternative Minimum Tax (AMT) was designed to ensure that tax payers with access to favorable tax shelters pay at least a minimum amount of tax.payment of ordinary income tax is that it raises your average tax rate paid which will lower the amount of AMT due almost dollar for dollar using the general formula just mentioned. As such, it is common for employees facing high taxes to have the Employee Stock Option Fund (ESO) cover the cost of exercising the NSOs while the employee exercises the less expensive ISOs at the reduced rate.

To calculate your savings precisely, follow the instructions on our AMT Calculator with the added instruction of entering your NSOs only after you've calculated your AMT. In other words, first determine your AMT and then enter your proposed NSO Exercise knowing that ESO will cover the NSO-related taxes. You'll notice how much your AMT goes down and that is a simple benefit that falls out of merely having ESO involved. Moreover, you can maximize your benefit by having ESO cover the cost of the AMT and ISO exercise as well.

The Employee Stock Option Fund can help alleviate the financial risk of exercising on your own by providing the funds to exercise stock options and to cover the applicable taxes. No repayment is due unless and until there is a liquidity event involving the company that issued the shares, such as a sale or IPO. If the final value of the stock is insufficient to repay ESO, ESO still bears the loss on your behalf.

For more information regarding how working with ESO can benefit you, please contact us. Note that 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.

 

Purchase Stock Using an IRA

It is very common for founders or early employees to have an opportunity to buy a substantial amount of stock in a promising startup company at a very low price. If your Individual Retirement Account (IRA) is sufficiently funded, you can create an IRA account at a special financial institution such as Pensco, rollover just enough money to this IRA, and then purchase your stock or exercise your stock options using that IRA money. By doing so, all gains on this investment will accrue tax-deferredBy doing so, all gains on this investment will accrue tax-deferred until you withdraw the money at age 59 1/2 or higher. This is especially beneficial if you experience a hot IPO in a bubble market. Normally, if you sell your stock in order to preserve the large gains, then you'll be immediately subject to capital gains taxes. On the other hand, if your investment is held in an IRA, even selling the stock will not trigger taxes and you'll have captured profits without having to endure years of price volatility.

Roth IRA

Normally, highly compensated employees at fast growing technology companies are not eligible to make Roth IRA contributions. However, the IRS frequently allows IRA conversions as a mechanism to generate near term tax revenue for the government. During such a window, you can convert your IRA into a Roth IRA by paying the taxes on the amount converted as if it was an authorized distribution. Although the taxes paid effectively increases the amount that you have invested in your stock, your return on investment can be enormous since the final proceeds will be tax free for the most part as opposed to merely tax deferred in the case of regular IRAs. Note that the amount of taxes you pay on your Roth conversion will be a function of the fair market value of your stock at the time of conversion, so it is best that you do it early on while the valuation is still low. Although Qualified Small Business Stock(QSBS) exemptions can be less expensive to execute, the tax savings is limited to federal tax for many states, the investment must be held at least 5 years, and the exemption on capital gains is capped at the higher of $10 million or 10x the invested capital. Although an investment using a Roth IRA doesn't have those QSBS limitations, it is subject to many other restrictions. Be aware that the rules governing IRA's outline a number of prohibited transactions including self dealing in situations where you control the asset in which you invested. That can be risky for founders who own a large percentage of their companies. Since this is a grey area of the law, it is highly recommended that you seek professional advice before doing this.

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. 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 specific tax related support related to stock option exercises, please contact Scott Chou.

© 2012-2018 Employee Stock Option Fund. All Rights Reserved. The ESO Fund does not provide legal, financial, or tax advice.

 

Qualified Small Business Stock

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. 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 capitalization 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.

Exercise Just Enough Options Each Year To Avoid AMT

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.

© 2012-2018 Employee Stock Option Fund. All Rights Reserved. The ESO Fund does not provide legal, financial, or tax advice.