Equity Compensation Advisor

Generally, it is preferable to exercise ISOs early in the year to start the one-year holding period to qualify those shares for the long-term capital gain rate. However, with the S&P up over 10% in the third quarter, it may be time to revisit ISOs that may be ripe for harvesting. 

First, we need to project what the Alternative Minimum Tax (AMT) Buffer will be for the 2010 tax year.  This is the amount by which regular income tax is projected to exceed Tentative Minimum Tax (TMT).  The AMT is triggered when the TMT exceeds the regular income tax.

Example: It is projected that your regular income tax is $85,000 and your TMT is $70,000.  In this situation, your AMT Buffer is $15,000 ($85,000-$70,000).

For planning purposes, the bargain element (spread) on the exercise of an ISO is treated as income under the AMT, but is not treated as income under the regular income tax.  Therefore, ISO’s may be exercised up to the AMT Buffer amount without incurring any additional tax.  However, AMT credit from previous years will reduce the AMT Buffer amount.

Dan’s Moral: Knowing the amount of AMT buffer can save thousands in taxes.

Securities offered through LPL Financial Member FINRA/SIPC

An executive who makes the decision to exercise stock options should be clear about the expenses associated with the transaction. Here are the three types of expenses to consider.

The first cost is simply the exercise price of the option. For example, if 5,000 option shares were issued at $15 per share, the cost to exercise all 5,000 shares is $75,000 ($15 per share x 5,000)—no matter what the current price per share is. 

When non-qualified options are exercised, the gain (or bargain element) is subject to withholding tax. In the above example, the bargain element subject to tax is $50,000; the gain is $10 per share ($25-$15) x 5,000 shares. However, if you are not an employee of the company (director, consultant, etc.), withholding does not apply upon exercise. Rather, the income will be reported on a 1099-MISC. When the exercised shares are ISOs (incentive stock options), the employer withholds no tax.

Lastly, the financial institution performing the transaction may impose fees, which can vary dramatically depending on the level of the institution’s involvement. In addition, a commission may be charged on the number of shares exercised.

Dan’s Moral: Look before you leap; understand all costs before exercising options.