February 2001 Hot Topics - part 2 of a 2-part series

Employee Stock Options - A Primer, Part 2

I.       THE LIFECYCLE OF AN ISO

 Assume on January 1, 1999 you received an ISO for 40,000 shares exercisable at $0.10/share and the fair market value of the stock was $0.10/share.  The ISOs cliff vests as follows:  For the first 12 months, none would be vested; on January 1, 2000, 25% would be become vested and thereafter, the remaining 30,000 shares would vest ratably over 36 months.  Once the ISO was exercised, you would receive the stock, subject to the company’s first right of refusal. 

A.    If You Early Exercise

If the company gave you the right to exercise the ISOs early and you exercised your ISO on February 1, 1999, then you would have paid $4,000 to the company for 40,000 shares.  Since there would be no spread, you’d have no tax preference under the AMT and no compensation income, provided you made a Section 83(b) election within 30 days of the date you received the stock.  Your tax basis in the stock is $4,000. 

Assume on May 1, 2000 the company has an IPO and you are locked-out for 6 months.  If you held the stock until January 1, 2001 and then sold it for $20.00/share, you would have a long-term capital gain of $796,000 ($20/share x 40,000 = $800,000; $800,000 - $4,000 basis = $796,000 gain) taxed at a maximum federal rate of 20%.   Note:  You have to hold the stock until January 1, 2001 to meet the ISO rule requiring that you hold stock at least two years from the date of grant.

Employee Stock Options - A Primer

php 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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