See how Wealthfront can help you reach your financial goals. This is not just a Hollywood story. In my past role as a tax accountant in Silicon Valley, I saw many executives and employees get greedy, too. A surprisingly large number of people fall into this trap. Some of them are just ill-informed. Others, I believe, are overcome by their greed: It causes them to forget that stock prices can go down as well as up, or keeps them from embracing a rational plan to pay the taxes.
The employer decides how much to withhold, based on guidelines from the IRS and the states. Unless you sell stock at the time of exercise to cover your withholding, you will have to write a check to your employer for the taxes withheld. If you have incentive stock options ISOs , your employer will not withhold taxes. Whether you have NQOs or ISOs, you will need to set aside money held in another account, like a savings or money market account, to pay taxes.
Following are two scenarios that show what can happen if you get greedy and exercise as many options either non-quals or ISOs as you can without a plan.
You might find yourself in a financial quagmire, stuck owing more in taxes than you have cash on hand to pay. The loss deduction may be subject to annual limits, so your tax savings may not be realized for many years.
Also note that you will have a different basis in your stock for regular tax and AMT purposes, as well as an AMT credit carryover, which should be taken into consideration.
Do these scenarios sound unlikely? I have seen versions of them happen dozens of times, often enough that I tell this cautionary tale whenever I can. This is commonly referred to as a cashless exercise. On exercise, you immediately sell enough stock to pay both the exercise price and your anticipated tax liability. But remember that you should still set aside some money for the incremental tax due. If you hold stock from previously exercised options, that gives you the opportunity to sell the stock as you exercise additional options.
This choice can be particularly beneficial if stock has been held for over one year and the associated gain qualifies for favorable long-term capital gain tax treatment. Be just as rational when it comes to your options as you are when you are planning your investment portfolio. That may mean parting with some of the potential upside to avoid a catastrophic downside. 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 particular 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. Bob Guenley was a tax accountant to Silicon Valley executives from the s through the s, and currently works for a leading venture capital firm.
Explore our Help Center or email knowledgecenter wealthfront. Many young executives worry about triggering taxes by exercising options. But, as Kent Williams, founding….
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Disclosure 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 particular tax consequence. About the author Bob Guenley was a tax accountant to Silicon Valley executives from the s through the s, and currently works for a leading venture capital firm. View all posts by Bob Guenley. Tags career advice , career planning , employee compensation , mistakes , stock options , taxes Questions?
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