By |Published On: Apr 8, 2024|Categories: Financial Planning, RSUs|

Remember our dear friend Sophia? She works at a healthcare AI startup and loves pizza from the parlor with one of those large, piping hot pizza ovens located just around the corner! Recently, we were chatting about Incentive Stock Option (ISOs) Taxes and how to use ISOs in the best way possible.

Don’t Feel Regret if You Don’t Use the ISO Tax Advantage

ISOs have long term capital gains, if you hold them long enough – 1 year from grant to exercise and 1 year from exercise to sale – 2 years altogether.

It’s important to know that if you exercise ISOs and sell right away or participate in an unforeseen disqualified sale within a year, the tax result is no worse than if you have nonqualified stock options (NSOs) or Restricted Stock Units (RSUs) that vest.

If you do have a disqualified sale, you should not feel bad about it. Sophia engaged in a disqualifying sale to put herself in a stronger financial position.

Sophia’s Disqualifying Disposition

Sophia participated in her company’s tender offer and sold 20% of her ISO shares by using a disqualifying disposition and put $77,500 in her pocket. Remember that her decision was based on her need for cash and a bit of diversification with her employer stock.

Furthermore, she will use some of the cash to exercise 10,000 ISOs when they vest later this year ($20,000 cost), hold onto them for their long term capital gains benefits, and have upside in future prospects of the company.

Although Sophia had to pay a higher tax amount on the disqualifying position, she was very comfortable with selling some of her equity to get some cash, and now she has more flexibility in her overall financial situation.

What This Means for You

You might feel like you’re losing if you don’t get long term capital gains on your ISOs. Remember that an ISO disqualifying disposition is taxed no worse than bonus, salary, or other forms of equity compensation.

Moreover, you don’t take on additional investment risk by owning more company shares and you won’t be subject to the Alternative Minimum Tax (AMT).

If you have ISOs and are unsure about what to do, let’s have a chat.