If you're working for a company who is compensating you with stock, you may have been lucky to receive incentive stock options. AKA, ISOs, are unlike other forms of stock compensation simply because, if done correctly, you can receive lower, capital gains tax treatment when sold.
Non-qualified stock options, NSOs, on the other hand, are taxed at your marginal ordinary income rate plus employment taxes (Social Security and Medicare) and are more common as a form of stock compensation.
When you work for an employer it’s almost always the case that you must pay ordinary income and employment taxes. The top rates are 37% federal, 12.3% California (if you live here), 6.2% for Social Security on the first $132,900 of income, plus 1.45% Medicare, and .9% of Medicare surplus, if it applies. This tax treatment involves everything from salary to stock that’s vested with the only exception being ISOs. A reason to exercise ISOs now is because of the new tax law changes that went into effect in January 2018, as part of the Tax Cuts and Jobs Act and because these rules still remain in effect.
When ISOs are exercised, or when you elect to buy the stock at the strike price, two things happen: you receive the shares and you will owe alternative minimum tax (AMT). The latter was the headache involved with exercising ISOs and has since become less of an issue due to the latest tax changes. AMT triggering thresholds have increased to $71,700 for singles and $111,700 for married couples filing jointly, from $54,300 and $84,500, respectively in 2017.^2 More importantly, the AMT exemption has increased even more considerably, $500,000 and $1m, respectively. This means you can exercise shares up to a higher amount and be less likely to pay AMT at tax time.
It’s up to you to decide if taxes will increase or decrease in the future. Exercising your in-the-money ISOs this year puts you in control by taking advantage of this year's tax rates and generous AMT thresholds. You don’t even need to make a decision to sell the stock to finally realize the capital gain, which must be done at least 1 year after exercise.
At Eureka Wealth Management, I help my clients manage their stock compensation, including finding strategies on tax treatment and advice on when to sell. Call for a free, initial consultation at (760) 537-0791 or online at eurekawealthmanagement.com. Consult your tax advisor about your tax situation. I coordinate tax advice with my clients’ other professionals.