Qualified Incentive Stock Options (ISOs), as opposed to Non-qualified Stock Options (NSOs aka NQSOs), are subject to favorable IRS treatment. The main benefit being not having to pay ordinary income tax on the spread between the fair market value (FMV) and the original exercise strike price when exercised. For NSOs, ordinary income tax on the spread is withheld at the point of exercise. However, ISOs are still subject to Alternative Minimum Tax (AMT) to prevent wealthy individuals from sheltering all of their income this way. The 100K Limit is another IRS rule to prevent the ISO program from being abused as a tax shelter.
The 100K Limit means that the maximum amount of ISOs that an employee can receive (vest) per year is $100K. The amount is computed by taking the per share FMV at the tine of the grant and multiplying by the number of shares granted. If the grant is subject to vesting such as a 4 year schedule, then the previous product is divided by 4 to determine whether the grant is under the 100K limit. If the grant is eligible for early exercise, then you do not divide by 4 since the number of shares is based on the number eligible for exercise that year. Any excess options and subsequent grants above the 100K limit are deemed NSOs and subject to immediate withholding tax at the time of exercise.
If you do have early exercise privileges that are subject to vesting or cancellation, then don't forget to file an 83(b). That establishes your long term capital gains start date or else it may default to the date you actually vested the shares and not when you exercised.
Exercising stock options early can require a lot of capital and yet the time to liquidity for your company can be quite long. As your shares are vested, you may be tempted to sell some shares to recover your original investment or perhaps fund other financial needs. Be aware that a sale is a taxable event and most likely at high tax rates when held for less than a year. A sale also truncates any possibility of future upside on the shares being sold. An alternative solution for partial liquidity is to get an advance from the ESO Fund. This is an attractive solution since you are not transferring title to the stock and still retain the ability to achieve unlimited upside. Furthermore, if the stock becomes worthless, ESO absorbs the loss, not you. For more information, please contact us at the Employee Stock Option Fund.
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Employee Stock Option Fund
999 Baker Way Suite 200
San Mateo, CA 94404
tel: +1 (650) 262-6670