The ESO Fund does not provide legal, financial, or tax advice. Alerts Log In Required. Consider all the factors above to make a decisions that fits your needs. Opening a bank account. You are likely to incur an AMT if you exercise your options after their fair market value has risen above your exercise price, but you do not sell them. Homeowners insurance policies Picking a home insurance company Filing a home insurance claim. Qualities of a Leader.
See how Wealthfront can help you reach your financial goals S tock options have value precisely because they are an option. Your stock option loses its option value the moment you exercise because you no longer have flexibility around when and if you should exercise. As a result many people wonder when does it make sense to exercise an option. The most important variables to consider when deciding when to exercise your stock option are taxes and the amount of money you are willing to put at risk.
There are three kinds of taxes you should consider when you exercise your Incentive Stock Options the most common form of employee options : alternative minimum tax AMTordinary income tax and the much lower long-term capital gains tax. You are likely to incur an AMT if you exercise your options after their fair market value has risen above your exercise price, but you do not sell them.
The AMT you paid will be credited against the taxes you owe when you sell your exercised stock. If we assume the same outcome as in the example above, but you wait to exercise until the day you sell i. Any future appreciation will be taxed at long-term capital gains rates if you hold your stock for more than one year post exercise and two years post date-of-grant before selling.
If you sell in less than one year then you will be taxed at ordinary income rates. The most important variables to consider in deciding when to exercise your stock option are taxes and the amount of money you are willing to put at risk. Most companies offer you the opportunity to exercise your stock options early i. If you decide to leave your company prior to being fully vested and you early-exercised all your options then your employer will buy back your unvested stock at your exercise price.
The benefit to exercising your options early is that you start the clock on qualifying for long-term capital gains treatment earlier. Very early employees are typically issued stock options with an exercise price of pennies per share. I always encourage early employees who exercise their stock immediately to plan on losing all the money they invested.
BUT if your company succeeds then the amount of taxes you save will be ENORMOUS. In many cases that might not be until you really believe your company is ready to go public. Earlier in this post I explained that exercised shares qualify for the much lower long-term capital gains tax rate if they have been held for more than a year post-exercise and your options were granted more than two years prior to sale.
To find the ideal time to exercise we need to work backwards from when your shares are likely to be liquid and valued at what you will find to be a fair price. When should you exercise your employee stock options shares are typically restricted from being sold for the first six executive stock options definition after a company has gone public. There is usually a period of three to four months from the time a company files its initial registration statement to go public with the SEC until its stock trades publicly.
Therefore you will take the minimum liquidity risk i. These characteristics included meeting their pre-IPO earnings guidance on their first two earnings calls, consistent revenue growth and expanding margins. Based on these findings, you should only exercise early if you are highly confident your employer can meet all three requirements. The higher your liquid net worth, the greater the timing risk you can take on when to exercise.
In that case you can better afford to lose some money, so exercising a little earlier once you are convinced your company is going to be highly successful without the benefit of an IPO registration may make sense. Exercising earlier likely means a lower AMT because the current market value of your stock will be lower. The difference between the AMT and long-term capital gains rates is not nearly as great as the difference between the long-term capital gains rate and the ordinary income tax rate.
In any case we strongly recommend you hire a great tax accountant who is experienced with stock option exercise strategies to help you think through your decision prior to an IPO. Disclosure The information contained in the article is provided for general informational purposes, and should not be construed as investment advice. This article is not intended as tax advice, and Wealthfront does not represent in any manner that the outcomes described herein will result in any when should you exercise your employee stock options tax consequence.
Prospective investors should confer with their personal tax advisors regarding the tax consequences based on their particular circumstances. Wealthfront assumes no responsibility for the tax consequences to any investor of any transaction. Financial advisory services are only provided to investors who become Wealthfront clients. Past performance is no guarantee of future results.
Andy Rachleff is Wealthfront's co-founder, President and Chief Executive Officer. He serves as a member of the board of trustees and vice chairman of the endowment investment committee for University of Pennsylvania and as a member of the faculty at Stanford Graduate School of Business, where he teaches courses on technology entrepreneurship. Prior to Wealthfront, Andy co-founded and was general partner of Benchmark Capital, where he was responsible for investing in a number of successful companies including Equinix, Juniper Networks, and Opsware.
Andy earned his BS from University of Pennsylvania and his MBA from Stanford Graduate School of Business. In this post, we compare the two services and explain the relative advantages of Wealthfront. Path helps you prepare for your financial future, every step of the way. Please read important legal disclosures about this blog. This blog is powered by Wealthfront. The information contained in this blog is provided for general informational purposes, and should not be construed as investment advice.
These contributors may include Wealthfront employees, other financial advisors, third-party authors who are paid a fee by Wealthfront, or other parties. Unless otherwise noted, the content of such posts does not necessarily represent the actual views or opinions of Wealthfront or any of its officers, directors, or employees. Your source for data-driven advice on investing and personal finance. See how Wealthfront can help you reach your financial goals. View all posts by Andy Rachleff.
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