Comment by brandmeyer | Hacker News Reader

Comment by brandmeyer | Hacker News Reader

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I've heard a variation on this that never quite made sense to me. Its possible that some relevant details were just lost in the retelling, and it goes like this:

The employee exercised his options shortly after an IPO, but before he could sell the shares. By the time he could sell the shares, the stock had fallen to the point that the proceeds from sale didn't cover his taxes due. It wasn't enough to drive them to the poor house, but it was the difference between making money and losing money.

Why would you exercise the options in this time window at all? What's the upside versus just sitting on them until the window opens up?

Why would you even be able to exercise the options in the trading blackout window? Doesn't that count as trading itself?

If both trades happened in the same calendar year, then wouldn't the capital loss from the sale wipe out the capital gain from the exercise, such that he only owed tax on the difference between the strike price and final sale price?

What am I missing from this picture?

The gap between your strike price and the current market value is ordinary income, not capital gains. The gap between the current market value at the time of exercise and time of sale is capital gains (or loss). You can only apply $3,000 per year of capital loss to ordinary income (but the remainder can be carried over to future years). AMT can also fuck you.

Suppose you have 1000 options with a strike price of $1, and your company IPOs at $10. If you exercise immediately you have $9000 of ordinary income. If a year later the stock is worth $0, you have $9000 of capital loss and can deduct up to $3000 of ordinary income for three years. If a year later the stock is worth $100 and you sell it, you have $9000 of ordinary income and $90,000 of long-term capital gains. If instead you wait a year to exercise your options and the stock goes up to $100, you have $99,000 of ordinary income and $0 of capital gains.

If your plan is to sell your stock ASAP, there's no reason to exercise before you can sell (unless your lockout is over a year or your options are going to expire), but if you plan to hold onto the stock then exercising at the lowest price you can is optimal tax-wise if the stock actually does go up.

Stock options are complicated and you should absolutely talk to a tax professional before doing anything with them.

> Why would you even be able to exercise the options in the trading blackout window? Doesn't that count as trading itself?

Exercising options isn't prohibited during a trading blackout, because it's not a market transaction. (Especially if you're only exercising with no sell to cover).

If your options are ISO, and you want to get the best tax treatment, it must be at least two years from grant and one year from exercise. If you joined around a year before the IPO, and you wanted the nice tax treatment, but to sell as soon as possible, then exercising near the IPO makes sense.

If you do sell in the same tax year (which isn't always a calendar year, many companies and some people have adjusted their tax year), then it's a capital loss (and a disqualified disposition), etc. But if the IPO is later in the tax year, the blackout may extend beyond, and you'ld owe AMT in one year, and maybe realize a big loss in the next. If you realized a big gain in the next year, you'd also get a big AMT credit, and things would work out; but the AMT credit isn't refundable, so it could take many years to get that back, more if you also lost your job because the company imploded.

Resignation can be a taxation event. If you’re getting taxed on the FMV of the options, you might as well lock in that price? You lose some cash, so that is a risk, but the big issue is taxation at resignation without liquidity. In Australia taxation at resignation stops being a thing on July 1st, thank god.

If you’re confident the sale of the stock in one year would net a profit, that one year between exercise and the sale allows for long-term capital gains treatment (usually 15% or whatever it is these days) vs short-term capital gains, which is taxed at your income level.

Worst case, it can be a 37% (federal) + 13% (CA) tax hit. Doesn’t make most people too happy, if you’re lucky enough to hit it that big.

Not a CPA, I’m sure there are different situations, but this is the simplest explanation I know of, from experience.

If you don't exercise them, you could lose them.

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