As an engineer at promising tech startup, Erin was eager to reap the maximum benefit from her incentive stock options (ISOs). But she knew the tricky Alternative Minimum Tax (AMT) rules around ISOs could lead to high premature taxes if not handled correctly. To capitalize on the potential wealth-building opportunities, Erin engaged United Tax for proactive planning tailored to her personal financial situation.
Understanding Incentive Stock Options
Stock options provide employees the right, but not the obligation, to purchase company shares at a fixed “strike” price over a defined period. If the market value increases above the strike price, the options become profitable to exercise.
ISOs receive special tax treatment if certain holding periods and other IRS rules are met. Unlike non-qualified options, no ordinary income tax is owed at ISO exercise. Instead, the profit is taxed at long-term capital gains rates on sale. This favorable tax treatment serves as a powerful employee retention and compensation incentive.
However, exercising ISOs can trigger the Alternative Minimum Tax (AMT) by creating an "adjustment" that boosts income for AMT purposes. This phantom income can push taxpayers into a higher AMT bracket, resulting in additional tax liability.
The Impact of AMT on Erin’s Stock Options
After a successful 5-year tenure at the company, Erin had accumulated ISO grants totaling over 50,000 shares with strike prices between $5-$10 per share. The company’s stock had climbed to nearly $50/share, priming her options for significant gains.
However, modeling out the tax implications under different exercise and sale scenarios revealed substantial additional AMT liability ranging from $20,000 up to $75,000. This extra tax hit would cut into Erin's net profit.
United Tax created personalized projections showing the impact of stagger exercising her ISOs over multiple years to smooth out the AMT impact. We also illustrated the consequences if Erin exercised all her options in one year or waited until close to expiration.
Strategic planning with United Tax empowered Erin to make wise timing decisions aligning to her own financial situation for optimal results.
Consulting on 83(b) Elections for New Grants
On top of her existing ISOs, Erin also received a new grant of 10,000 options annually as part of her performance incentives. United Tax advised Erin on whether to make a Section 83(b) election on the new options as they were granted.
The 83(b) election presets the tax basis of the options at grant value instead of waiting until exercise. This allows any gain to be taxed at preferential long-term capital gains rates rather than higher ordinary income rates on the vesting date gain. The trade-off is paying taxes earlier on options that may never actually vest.
Again, based on Erin's personal income, liquid assets, risk tolerance, and other factors, United Tax crafted a custom election strategy identifying which grants warranted the 83(b) route to maximize upside.
Guidance on Preparing for Possibilities with ISO Shares
After exercising her ISOs, Erin now faced decisions on when to actually sell the shares she acquired and how to handle the proceeds. Our advisors illustrated different scenarios around holding versus selling and the resulting tax outcomes.
We provided guidance on setting aside funds to cover future AMT liability triggered by ISO exercises but recouped in later years. We also reviewed options for leveraging the shares collateral for loans while retaining the upside.
Based on Erin’s objectives, United Tax designed an integrated financial plan addressing stock sale timing, tax mitigation tactics, and reinvestment of the liquidated shares to align with her personal goals.
Erin’s Reflection on the Difference United Tax Made
Reflecting on the experience, Erin remarked: “The team at United Tax empowered me to navigate the complexity of stock options to maximize their benefit. Their guidance on AMT avoidance, 83(b) election strategy, layered selling scenarios, and integrated planning makes me feel in control. I have confidence in reaping the full value of this career-accelerating compensation package thanks to United Tax’s hands-on counsel.”
At United Tax, our tax professionals regularly collaborate with professionals like Erin to optimize equity compensation through scenario modeling, strategic tax planning, and personal finance integration tied to each client’s unique financial life. If you have stock options and want to minimize taxes while building wealth, please contact us for a consultation today.
