Think of ISOs as the right (but not obligation) to buy your company’s stock at a preset - or “strike” - price. Since your cost for the shares is fixed at the strike price, you have a gain (and benefit) if the shares are sold above the purchase price.

ISOs are unique from “non-qualified” stock options (often called NSOs or NQSOs) in that they have the potential for a lower tax bill as well. If certain grant and holding requirements are met, the appreciation may be treated as a long-term capital gain (LTCG) as opposed to ordinary income. For most taxpayers, LTCG rates are typically lower than ordinary income rates.

Selling Too Soon: Exercising in one tax year and selling in the next before 365 days runs the risk of incurring both 1) AMT and 2) higher ordinary income tax rates through a disqualifying disposition.

Insufficient Cash for AMT: Once AMT is triggered, the bargain element is taxed at 26% or 28%. Not considering AMT can result in a massive surprise tax bill and cash dilemma.

Not Utilizing Multiple Strategies: A multi-strategy approach using a combination of qualifying and disqualifying dispositions may create an appropriate balance of deconcentration, risk and return, and cash flow management.

Only Considering Taxes: Taxes matter, but they shouldn’t be the only consideration. Evaluating concentration risk, financial goals, time remaining at the company, and other key factors is essential for aligning ISOs with your personal situation.

AMT is not triggered by receiving a grant, vesting, or holding vested ISOs. AMT only begins to come into play upon exercising. Exercising in-the-money ISOs adds to AMT taxable income.

The AMT exemption usually provides some ‘wiggle room’ for exercising before AMT is triggered. Tax projection software is very helpful for estimating the number of ISOs that can be exercised before AMT is triggered.

The closer the strike (exercise) price is to the company’s fair market value (FMV), the greater share quantity can be exercised.

Early exercises may be valuable for minimizing AMT due and maximizing capital gains treatment.

AMT can be recaptured as a credit toward regular income tax in future years. A proactive strategy for utilizing AMT credit can help recapture AMT credit sooner.

At a bare minimum, options must be in-the-money or at-the-money. It almost never makes sense to exercise stock options that have a higher strike (exercise) price than the current share price. These are referred to as out-of-the-money stock options.

Exercising while the current stock price is lower - often when the company is pre-IPO - may reduce total taxes paid over time. However, the risk of shares going underwater (the current value falling below the exercise price) is greater in this scenario.

The cost to exercise is quantifiable. Since an optionholder is required to pay to purchase the shares, a viable plan for 1) paying with cash on-hand, 2) exercising and immediately selling, and/or 3) securing outside funding is essential.

Along the same lines, exercising ISOs can trigger AMT. Exercising beyond the AMT exemption is usually wise only when a plan for paying the AMT due is created in advance.

Not necessarily. Calculating the tax savings against the risk that comes with 1) buying the shares, 2) paying any AMT, and 3) holding the shares for a prolonged period of time is crucial. Understanding this balance within the context of your personal goals is the best framework for understanding whether the benefits of a qualifying disposition outweigh the downsides.

In my experience, a combination of qualifying and disqualifying dispositions is often the best strategy for balancing all of the considerations above.

Any unvested ISOs are, of course, forfeited. For vested but unexercised ISOs, two factors affect your choices:

•The plan document and

•The Internal Revenue Code (IRC).

The IRC states that all ISOs (or “qualified” stock options) must be exercised within three months of ending employment to receive favorable tax treatment. However, your plan document may allow ISOs to convert to non-qualified stock options (NQSOs or NSOs) after three months. The NQSOs then have a specific expiration. For example, the expiration may be a) one year from ending employment or b) the original stock option expiration, whichever comes first.

RS and RSUs are an obligation for your employer to give you shares of company stock once you’ve met certain terms. Companies like to issue RS and RSUs because doing so directly ties employee compensation to stock performance.

“Restricted” simply refers to the fact that you do not own the shares until certain criteria are met, such as a vesting schedule based upon remaining employed by the company for a certain period of time. Once the criteria are met, the shares vest, become unrestricted, and are delivered to you in your brokerage (e.g., Fidelity, E*TRADE, Shareworks) account.

Technically? Certainly. In practice, most employees hardly notice the difference. However, several notable differences are:

•RSUs are far more common than RS.

•By default, RS holders are entitled to any dividends while RSU holders are not. However, many companies will elect to provide a “dividend equivalent” in the plan.

•RS are eligible for 83(b) election whereas RSUs are not. This allows RS holders the option to pay taxes at grant as opposed to vesting.

The good news: employees don’t pay taxes until the shares vest.

The bad news: you have little to no control over when the tax bill hits. Multiple and/or large grants vesting in a single year can unwittingly push employees into a higher tax bracket. Additionally, changes in the stock price – either up or down – may have an outsized effect on your actual taxable income for the year. For those receiving RS and RSUs, tax planning for these variables on an annual basis is important to not pay more than necessary.

At vesting, not really. You’ll be taxed based on the full value of the shares at vesting. The value will be taxed as ordinary income, and this becomes your cost basis for tax purposes. Any future gain or loss will be based on the vesting value and taxed as a capital gain/loss (either short or long-term), but that holding period has no effect on the taxes you will pay at vesting.

Let’s look at a quick example. 1,000 RSUs vested at a share price of $50. The value at vesting - $50,000 - is taxable as ordinary income. Whether you continue to hold the shares or sell after vesting doesn’t impact the $50,000 income or how it is taxed; that event is effectively ‘locked in.’

For my clients, the tax withholding rates on vesting restricted stock (RS) and restricted stock units (RSUs) are usually too low to cover the tax bill. The reason for this is relatively straightforward: the withholding rate on vesting RS and RSUs is typically 22% for federal taxes. Most of my clients receiving RS and RSUs are in the 24%, 32%, or 35% brackets, leaving a deficit that must be made up elsewhere. State income taxes apply as well and vary from state-to-state. For example, Oregon and California’s withholding rate on RS/RSUs is 8% and 10.23%, respectively.