When should i exercise my incentive stock options

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  • Should I Exercise My Employee Stock Options??

About Us. Who Is the Motley Fool? Fool Podcasts. New Ventures. Search Search:. Jun 9, at AM. A variation on this approach is that the company could allow option exercises using a promissory note. The company would loan the employee the money for the exercise and tax costs. But again, the company would have to use its balance sheet for the taxes. And there are some other restrictions around promissory notes. These kinds of notes are typically only provided to an officer or director of the company or sometimes to a small handful of employees who have a common circumstance.

There are also limits on the number of outstanding loans a company can carry. Lastly, a company could give bonuses to employees to cover the exercise and tax costs.

Evaluating the pros and cons of exercising stock options

If the employee would rather use those funds for something else, that has to be allowed. If the bonus can only be used to exercise the option, then that raises a A problem.

How to know when it’s time to exercise your stock options

And, obviously, the company may want or have to use its cash for purposes other than employee bonuses. There is some good recent news: The Tax Cuts and Jobs Act of could potentially hold some upside when shares become liquid, by deferring taxation for up to five years until liquidity is achieved in limited cases. However, this new law includes several onerous requirements that are likely to significantly limit its appeal.

To see if that applies to you, have your financial planner look closely at the Tax Deferral for Option Exercise — New Section 83 i Election of the act. In the end, all of these solutions have complications. We recently assisted a later stage startup to explore a number of these options for one of its executives. They thought about providing a loan to the executive. But what seemed like a straightforward exchange based upon the total value of the ISO became a lengthy unresolved negotiation— what was the true current value of the stock, was the A a fair and accurate representation of the valu e, how many shares of RSUs did it equate to, how to minimize the tax obligation?

Two types of stock options

And solving for the needs of a few does not end the problem as typically an ever increasing number of employees will be approaching the year expiration date. As the numbers increase, the math makes it not feasible or desirable for a company to use some of its cash to help employees. It gives the employee a path to pay for the exercise and tax costs.

But it gets trickier as the company moves along in value. Once the stock value has appreciated, exercising and using the 83 b election could equate to a meaningful check from the employee. This is spread is taxed as ordinary income, added to your W-2, and your company will withhold for taxes. With Incentive Stock Options, if you follow all the IRS rules, you do not pay taxes when you exercise, only when you sell the shares, AND the spread is taxed at preferential long-term capital gains rates.

This difference between long term capital gains tax rates and ordinary income tax rates on the spread can save you thousands of dollars if executed correctly. To qualify for the special tax status, you need to hold the acquired shares for at least two years from grant date and one year from exercise. This normally lines up with a one year vesting period before you can exercise, and holding the shares another year after exercise.

What Does It Mean to Exercise a Stock Option?

Wait until the options vest after one year, then exercise as soon as possible to start the 12 month clock before you can sell. If your employer is publicly traded, you could open a brokerage account and buy shares of your employer stock all by yourself. You can participate the same way as everyone else. With stock options, you have the opportunity to participate in the increase of the stock price without spending any of your own money.

Tick Tock, the 10-year Expiration of Incentive Stock Options (ISOs)

This is leverage, and this is pretty powerful. As the share price goes up and the spread increases, the effect of the leverage diminishes. Wait until the Fair Market Value goes up enough that the benefits of leverage are mitigated. You need to have outside assets to fund the exercise. This could be cash in your checking or savings account that you have built up possibly in anticipation of this exercise or non-qualified investments not in retirement accounts. Delaying exercise can allow you to use that money that would go to exercising options to better use.

Along with the idea of leverage, investing outside assets can theoretically increase your net worth more than using that money to exercise ISOs. And your willingness to put your own money at risk to exercise must consider the….

At an early stage start-up, there is a very real risk the company never has a liquidity event and the equity is never worth anything. Venture capitalists might invest in 10 different startups hoping that payoff to offset the losses from the other This changes when you exercise your options. You are taking money out of your pocket to buy shares in your company, even if it is at a very low price. For employees of startups, the risk of losing their investment may not be worth putting the money in to exercise.

For more mature private companies, the valuation and stock price matter a little more. If you were there early and have options with a low strike price, and now the company has grown enough that your spread is larger and you have less leverage , the odds of the company completely failing have reduced.

The stock price can still go down, possibly significantly, but the odds of going to zero might be comparable to other publicly traded companies of a similar size.