This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, November 26, 2000.
Part 2 of a 2-part series
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.coms 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. Heres how to avoid Joes plight.
Usually, Joe must wait until his options vest before he can exercise them, which can cause adverse tax consequences if the stocks 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: Joes company must allow Joe to "early exercise" his options, as many do. It is Joes 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:
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