Connecting Goals to Exercising ISOs

Chris Reddick |

If you work in a tech startup, one of the perks of this job is employee equity. The standard type of equity offered to early startups before they IPO is Incentive Stock Options (ISO). You could get ISOs as employee equity to encourage you to stay with the tech company and work hard to benefit from its success. With more tech companies coming here to relocate from the Bay Area in California to Austin, Texas, this has been a specially significant challenge for tech workers here to get the best information.

This blog post discusses why establishing goals with ISOs is vital to determine when you should exercise or essentially buy your shares of employee equity are. Unfortunately, there are no hard and fast rules, and it depends upon what your goals are with the employee equity. Always talk to a financial professional before you make this critical decision.

1) Buying a new home or another primary money goal: It seems like this is a common goal for early tech workers to want to buy a new home. One strategy is determining whether you have to pay AMT or the alternative minimum tax if you exercise the ISOs. A financial planner can estimate the amount of AMT owned, if any. You typically want to exercise up to the AMT crossover point if you can. If this is possible, you can exercise hold them for one year and perhaps sell the shares and get more favorable tax treatment on the difference between the exercise price and the fair market value at sale. Alternatively, you can exercise and sell the shares, not having to pay AMT but owing ordinary income taxes on the difference between the exercise price and the 401A (fair market value for tax purposes) evaluation at exercise. Of course, all of this depends upon whether there is a secondary market to sell your shares or a liquidity event such as a tender offer.

2) Holding for the future growth potential: The second approach is not selling the shares but exercising them and holding on as a long-term asset with potential future growth. It can be challenging to know how the company will do when it IPOs. Many companies do not do as well as anticipated. Unfortunately, this is the risk that many are willing to take. But if you are not willing to take this risk, it might make sense to exercise hold for one year and get long-term capital gains after exercise, then sell to diversify the investments. Remember that you need to hold them two years from when they are granted.

When it comes to ISOs, it comes down to goals! What do you want to do with the money? You cannot depend upon markets to perform well when you need the money. The great benefit of ISOs is that you can get an outstanding deal on company stock and use this to make your financial dreams come true. Your goals might be to hold on and perhaps get significant gains from the stock and be able to retire early; even knowing this might not be too likely, it might be a dream of yours. Or, more practically, you might be raising a family and want to purchase your first home and see ISOs as a way to make that dream come true.

The bottom line is it might be prudent to get someone else's opinion besides what you have heard at your office. Therefore, you are encouraged to reach out to me below, and we can discuss the various goals that you have our how your employee equity fits into these goals.


*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any federal tax penalties. Individuals are encouraged to seek advice from their tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.


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