Stock Options and Capital Gains

A few more hard earned lessons about early exercise of options and QSBS (Qualified Small Business Stock) for early stage startup employees, as follow up to my last post ➤ Early exercise is a huge benefit for early startup employees as it helps a lot with taxes and unlocks the QSBS benefit. You purchase both vested and unvested shares upfront. If you leave before all your shares vest, the unvested portion is repurchased by the company at your original strike price. ➤ Long-term capital gains rates: with early exercise you start the long term capital gains clock. ➤ Eliminates the spread problem: the delta between strike price and FMV (Fair Market Value) at the time of exercise. If your strike price is $1 but the FMV is $10 at the time of exercise, you still only pay $1 per share but the $9 of spread is added as an adjustment in the calculation of the Alternative Minimum Tax (AMT). ➤ The problem of spread can be exacerbated by a 90-day exercise window (you have 90 days to exercise your options after leaving the company) as you might be in a situation where are subject to AMT for illiquid stock. Early exercises eliminates this problem 💡 The main reason to not exercise early is the risk of losing the money but if you don’t believe in the company to use the early exercise benefit maybe you should not be there ➤ From options to QSBS: founders and investors purchase their shares directly from the company so their stock is QSBS. Employees, need to exercise their options while the the corporation is QSB. The company must allow early exercise or they vest and exercise some options before the $50M asset line has been crossed ➤ Your shares qualify as QSBS is you buy them directly from a domestic C-corporation with gross assets of $50M or less at the time of stock issuance (practically means to have raised less than $50M) ➤ $10M exclusion: The main benefit of QSBS is the exclusion of up to $10M in gains (or 10x your basis if it's more) from federal taxes. ➤ 5-Year holding requirement: to unlock the tax benefits ($10M tax exclusion), you must hold the stock for at least five years 💡 Gifted shares maintain the QSBS eligibility. That combined with the fact that the exclusion is per tax entity it means that if you gift QSBS shares to your parents or kids trust funds, etc. they get their own exclusion 💡 In an acquisition, if stock gets involved, that is usually organized as a tax-free stock exchanged. The acquirer stock you get in exchange for your QSBS inherits the benefits. This is important if at the time of the acquisition the 5 year requirement was not yet satisfied at the time of the transaction ➤ Rollover of QSBS: in certain situations, you can roll over your QSBS gains into another QSBS-eligible investment, deferring taxes. For example, when investing at a startup after selling your QSBS All this only matters upon success but it's an important benefit to early employees

Most founders will hand the IRS millions at exit. Not because they have to. Because they didn’t plan. Here’s what Qualified Small Business Stock (QSBS) changes: Section 1202 allows founders to exclude up to $10M in capital gains from federal taxes when selling qualified stock. Zero tax on: - Capital gains - Net Investment Income Tax (3.8%) - Alternative Minimum Tax But here’s the catch most founders miss: You need to file an 83(b) election WITHIN 30 DAYS of receiving restricted stock. This starts your 5-year holding period clock immediately, even before your shares vest. Miss this deadline, and you could lose millions in tax savings. The 3 critical requirements: → Your company must be a domestic C-Corp → You must hold the stock for 5 years minimum → Gross assets under $50M at issuance ($75M for stock issued after July 4, 2025) Example: A founder with a $2M basis could potentially exclude up to $20M in gains (the greater of $10M or 10x your basis). Always work with your Tax Advisor! Are you planning your exit strategy with QSBS in mind?

31% of employees receiving grants were provided with ISOs. But most are confused by them. Here’s what you need to know: → What are ISOs? ISOs (Incentive Stock Options) let employees buy company stock at a set price. They provide the right, not the obligation, to purchase shares. But there’s a catch: only $100K of ISOs can become exercisable per year—the rest are treated as NSOs. Key Terms to Know: • FMV – Fair Market Value (current price) • Grant Date – When the option is awarded • Strike Price – Price at which you can buy • Exercising – Buying the stock • Vesting – When shares become eligible to exercise → Why They Matter: ISOs let employees participate in company growth without upfront cash comp. They also create “golden handcuffs”, incentivizing employees to stay until options become valuable. But they come with risks, especially in startups. Example: • Strike Price: $1 • FMV at Exercise: $5 • Exercising 1,000 shares → Cost = $1,000 • Worth at FMV = $5,000 The $4,000 gain is called the bargain element—and it impacts taxes. How ISOs Are Taxed: To get long-term capital gains rates: → Hold 1+ year after exercise → Hold 2+ years after the grant date Sell early? The gain gets taxed as ordinary income instead. The AMT Catch: Unlike NSOs, ISOs aren’t taxed at exercise for regular income tax. BUT—the bargain element triggers Alternative Minimum Tax (AMT) calculations. When exercising, AMT considers: → The bargain element (FMV – Strike Price) → The number of shares exercised → Your income Miss this step, and you could owe thousands in surprise taxes. Strategies to Manage AMT: Exercise in stages – Avoid a huge AMT hit in one year Time exercises carefully – Align with income levels Plan before an IPO – A stock price surge can mean a massive AMT bill Early Exercise Option: Some companies allow early exercise, meaning you exercise before vesting to start the holding period early. Final Note: It can be complicated at first (as it already is). Here’s a visual showing an example of what this could look like: ISOs are powerful but require planning. If left unchecked, AMT can create a huge tax burden if ignored. Got ISOs? - - - - - - - - - - - - - - - - - This is not financial or tax advice and purely educational. Always plan before acting. Like money visuals to spice up your finances? Every week I send a money visual that explains finances in 5th grader language. Join the fun here: https://lnkd.in/gJC9mTQH

Biggest tax win to date for a client: $125,000 refund in one year, and likely $200k+ over three years. Here's how it happened: A few years back, this client exercised a ton of incentive stock options with a big gain, and it triggered a massive tax bill. Ultimately over $450,000 to the IRS. Over the next few years, he sold stock, but only saw about $10k a year come back through AMT credit. Meanwhile, he kept paying even more in capital gains tax. This spring, he reached out after seeing one of my LinkedIn posts on AMT credits. His words: "I paid hundreds of thousands of AMT when I exercised my shares...Each of the last few years I’ve just seen about $10k come back to me in federal taxes (surprisingly a bit more from CA taxes) through AMT credit. You think this is a red flag?" We started working together and dug in. And what we found was that he'd essentially been leaving the IRS a six-figure tip. When you exercise and hold ISOs, the IRS actually tracks your cost basis two different ways: regular tax and AMT. He'd only been reporting one side of the equation, which meant he wasn't capturing the credits he was entitled to. With the help of a great tax preparer, we went back, fixed the reporting, and started amending returns. For the 2022 tax year alone, he'll be getting over $125k back between federal and state taxes. And we expect sizeable refunds for 2023 and 2024 a well. --- Stock option planning doesn't end at exercise. Most smart, successful people still miss this step, and it can cost them more than they realize.

She exercised $300K in stock options at the worst possible time. Her company's stock had been climbing all year, and she felt confident. She thought, “I should cash out while it’s high. Lock in the gains.” So she exercised all her options in one transaction. When the tax bill came, her stomach dropped. $125,000 owed. “Wait, what? I only made $300K.” She’d been pushed into the highest income brackets and hit with a brutal AMT calculation. All that time building those options. One decision and a third of it was gone. Here’s what she could have done instead: → Spread the exercises across multiple years → Coordinate with salary + bonus timing → Use tax-loss harvesting to offset gains → Plan around AMT thresholds When we spoke, she told me: “I thought the hard part was timing the stock. Turns out, it was timing the taxes.” That’s the real risk with equity comp. Not market timing but tax timing. If you have stock options and want to avoid this mistake, DM "OPTIONS" and I'll send you my 1-page checklist of questions to ask before you exercise.

Have equity options (specifically ISOs) and think they are worth something?  Then you need to understand the Alternative Minimum Tax (AMT). 𝐖𝐡𝐲 𝐢𝐬 𝐭𝐡𝐢𝐬 𝐢𝐦𝐩𝐨𝐫𝐭𝐚𝐧𝐭? One of the biggest downsides of ISOs is the potentially large tax bill that can come with them—especially when you exercise before a sale. You are taxed on the fair market value even though you’re not receiving any proceeds. There are many variables at play, but this could mean writing a significant check to the IRS if you exercise before a sale. 𝐒𝐨, 𝐰𝐡𝐚𝐭 𝐢𝐬 𝐭𝐡𝐞 𝐀𝐌𝐓? The AMT is an alternative tax rate that runs parallel to your ordinary tax rate. When you exercise options, it can increase your AMT income, thus raising your tax payment. 𝐇𝐨𝐰𝐞𝐯𝐞𝐫, 𝐭𝐡𝐞𝐫𝐞 𝐚𝐫𝐞 𝐬𝐭𝐫𝐚𝐭𝐞𝐠𝐢𝐞𝐬 𝐭𝐨 𝐦𝐢𝐧𝐢𝐦𝐢𝐳𝐞 𝐭𝐡𝐢𝐬 𝐩𝐚𝐲𝐦𝐞𝐧𝐭. One approach I’ve used over the past few years is to exercise a small portion of options each year. Toward the end of the year, I consult with my accountant to understand my AMT limit, so I know how many options I can exercise without triggering additional taxes. This strategy also allows me to benefit from long-term capital gains on the shares I’ve exercised. So, if you think your options are worth something (and be sure they are—if you raised money in 2021, there’s a good chance they might be worthless), get in touch with your accountant and ask about this strategy. It can help you save money in the short term and make more in the long term. And if your accountant isn’t familiar with this, ping me—I’ll put you in touch with mine.

Here’s the one thing no one tells you about stock options… In the early days of my career, I was fortunate to be part of a few high-growth companies that went on to massive exits. And while the ride was exciting, there’s one thing I really wish someone — a mentor, a manager, anyone, had sat me down and explained: Stock options are way more complicated than they look. Yes, they’re part of the upside. Yes, they can be life-changing. But what people rarely talk about is what it actually means to exercise them and the very real financial risk that comes with it. Let me break it down: Let’s say you join a company super early and rack up a large equity grant. Y ou crush it, the company takes off, and suddenly it’s worth billions. 🎉 Congrats! you’re sitting on paper millions. All you need to do is buy your options. Easy, right? Well… here’s the catch. Your strike price might be low, but the Fair Market Value (FMV) of the stock has skyrocketed. The IRS sees that as a taxable gain even if you haven’t sold a single share. So now you’re faced with: A massive tax bill due immediately No liquidity event in sight And the real possibility you could lose all that money if things change Sound insane? It is. Especially for people who don’t come from wealth and can’t just borrow millions from a generous uncle or wire it from a trust fund. It’s a broken system. And worse, it’s one that’s rarely explained to employees, even as equity is pitched as a “meaningful” part of the comp package. If you’re offering options, educate your team. If you’re receiving options, ask hard questions. Equity isn’t just upside. It’s responsibility and sometimes, a serious liability. It’s time we talked about that more.