Tax Planning With Options - Part 2

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper,  November 26, 2000.

Copyright 2000  Robert L. Sommers, all rights reserved.

Part 2 of a 2-part series

Tax Planning With Options

In the previous column, Joe, an employee of Acme.com received 25,000 incentive stock options (ISOs) and 20,000 non-qualified stock options (Non-Quals). He exercised 10,000 ISOs when Acme.com’s stock was trading at $100/share (a spread of approximately $1 million); then the stock dropped to $30/share. Joe has a potential Alternative Minimum Tax (AMT) of $350,500 payable on April 15, 2001, even though the value of his stock dropped to $300,000. Here’s how to avoid Joe’s plight.


Early Exercise and Elect Taxation under Sec. 83(b)

Usually, Joe must wait until his options vest before he can exercise them, which can cause adverse tax consequences if the stock’s value increases during the vesting period. (See the sidebar for definitions.) If, however, Joe is allowed to exercise his options early, he receives unvested stock for his unvested options. Then, because Joe would own stock, he would be entitled to a special election under Sec. 83(b) (generally unavailable when options are owned), permitting him to be taxed immediately on the spread, rather than waiting until the stock has actually vested.

Note: Joe’s company must allow Joe to "early exercise" his options, as many do. It is Joe’s best alternative because there is little downside risk. Usually, the company will hold the stock in escrow until the shares are vested, but Joe still is considered the owner for Sec. 83(b) purposes.


NOTE: The balance of this article has been incorporated into the Tax Prophet's Action Guide entitled, "Employee Stock Options - A Primer" described below:

Employee Stock Options - A Primer

This Action Guide is the product of the author's extensive experience in negotiating stock options as part of the compensation package paid to employees and contractors. In addition, the author represents several taxpayers who confronting huge tax bills stemming from the exercise of employee options and the subsequent crash of the stock market.

This Action Guide defines the key terms and concepts involving both incentive stock options (ISO's) and non-qualified stock options, identifies the tax-triggering events and discusses strategies to minimize the tax impact. The guide discusses the alternative minimum tax as applied to ISOs as well as sophisticated tax-planning concepts. This guide is a must read for employee or company that receives stock options as part of their compensation.



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All contents copyright 1995-2003 Robert L. Sommers, attorney-at-law. All rights reserved. This internet site provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet® is a registered trademark of Robert L. Sommers.