Moral 1: When exercising options, sell enough on the same day to pay the tax bill.
Moral 2: When dealing with large sums like that, consult with a CPA.
The employee exercised his options shortly after an IPO, but before he could sell the shares. By the time he could sell the shares, the stock had fallen to the point that the proceeds from sale didn't cover his taxes due. It wasn't enough to drive them to the poor house, but it was the difference between making money and losing money.
Why would you exercise the options in this time window at all? What's the upside versus just sitting on them until the window opens up?
Why would you even be able to exercise the options in the trading blackout window? Doesn't that count as trading itself?
If both trades happened in the same calendar year, then wouldn't the capital loss from the sale wipe out the capital gain from the exercise, such that he only owed tax on the difference between the strike price and final sale price?
What am I missing from this picture?
Suppose you have 1000 options with a strike price of $1, and your company IPOs at $10. If you exercise immediately you have $9000 of ordinary income. If a year later the stock is worth $0, you have $9000 of capital loss and can deduct up to $3000 of ordinary income for three years. If a year later the stock is worth $100 and you sell it, you have $9000 of ordinary income and $90,000 of long-term capital gains. If instead you wait a year to exercise your options and the stock goes up to $100, you have $99,000 of ordinary income and $0 of capital gains.
If your plan is to sell your stock ASAP, there's no reason to exercise before you can sell (unless your lockout is over a year or your options are going to expire), but if you plan to hold onto the stock then exercising at the lowest price you can is optimal tax-wise if the stock actually does go up.
Stock options are complicated and you should absolutely talk to a tax professional before doing anything with them.
Exercising options isn't prohibited during a trading blackout, because it's not a market transaction. (Especially if you're only exercising with no sell to cover).
If your options are ISO, and you want to get the best tax treatment, it must be at least two years from grant and one year from exercise. If you joined around a year before the IPO, and you wanted the nice tax treatment, but to sell as soon as possible, then exercising near the IPO makes sense.
If you do sell in the same tax year (which isn't always a calendar year, many companies and some people have adjusted their tax year), then it's a capital loss (and a disqualified disposition), etc. But if the IPO is later in the tax year, the blackout may extend beyond, and you'ld owe AMT in one year, and maybe realize a big loss in the next. If you realized a big gain in the next year, you'd also get a big AMT credit, and things would work out; but the AMT credit isn't refundable, so it could take many years to get that back, more if you also lost your job because the company imploded.
Worst case, it can be a 37% (federal) + 13% (CA) tax hit. Doesn’t make most people too happy, if you’re lucky enough to hit it that big.
Not a CPA, I’m sure there are different situations, but this is the simplest explanation I know of, from experience.
Not to say I'm not working on it though, but if paying taxes would put me on the street, guess what, I'm not paying them until whatever they pay for lets me live a life. Just like any other debt, if I'm put in a vulnerable position, debts don't get paid unless they someone else owns the thing I'm living in or depend on, or they can break my legs, like the bank. One could argue you shouldn't have made that particular risky financial move, or you shouldn't be taxed on reception of illiquid assets, which would also both be valid.
We don't just get to unilaterally declare that 'I'll be uncomfortable paying taxes, so it can wait'... and then not bother to file or negotiate a plan, which seems to sum up OP's position. Wish him/her luck, they'll need it!
In the end, it's in the interest of the State, like any other creditor, that you don't actually die of starvation (or worse). Getting a continued stream of money, even if smaller than you expected, is better than getting no money at all.
ive known a number of people that got mildly burned by taxes, nothing crazy just unexpected, but with bigger numbers it could have been bad. When you have ISO(incentivized stock options), one of the incentives is you dont pay tax until you sell, which sounds great. There's this other way of calculating taxes, AMT(alternative minimum tax) which does not respect ISO, and you pay whichever is bigger. normally people dont get near AMT amounts, so most people dont know it exists. So when you exercise you think theres no tax, but then you do your taxes and realize actually you owe tax on money you never received.
That assumes the stock is trading publicly or at least you can legally sell them.
In India most of the companies ask you to exercise your options within 2-3 months of quitting job. And most of them are not public companies. So there's a big dilemma. Exercise and take tax hit and hope that the company goes public and doesn't tank post IPO. Don't exercise and possibility of big regret. So..sort of a bummer.
Ironically (and sadly) two of the most publicised IPOs in India (PayTM and Zomato) have tanked since their IPO.
I'm not investing in any IPOs unless it's at fire sale prices, and I know my line in the sand where I will take a loss rather than hope and pray.
The Rational Reminder podcast had an episode on them a little while ago:
> We’ve previously compared IPOs to lotteries that are prone to inflated valuations and low returns. Today we welcome “Mr. IPO,” Professor Jay Ritter onto the show for a deeper dive into IPO performance, for his insights into SPACs, and to hear his research into why economic growth doesn’t correlate with stock returns. Early in the episode, Jay unpacks how long-term IPO returns perform against first-day trading. While exploring the role that venture capital plays in tech IPOs, Jay talks about why negative earnings don’t affect tech IPOs in the short-term before sharing how skewness factors tend to impact young companies. Reflecting on how IPOs are usually underpriced, Jay discusses how the interests of companies are not aligned with the interests of IPO underwriters. After looking into IPO allocation, Jay compares the 2020 ‘hot IPO market’ with the internet bubble of the late 90s. Later, we ask Jay about what special-purpose acquisition companies (SPACs) are and why they’ve exploded in recent years. His answers highlight their investing benefits, risks, and why SPACs might be a better option for companies than IPOs. We examine how SPACs have historically performed and then jump into our next topic; why economic growth isn’t a good indicator that a country is worth investing in. He touches on why returns don’t correlate with economic growth, the place of capital gains and dividend yields when investing abroad, and how innovations in an industry can lead to higher stock returns. We wrap up our conversation by asking Jay for his take on whether the stock market is efficient before hearing how he defines success in his life. Tune in to hear our incredible and informative talk with Jay Ritter.
* https://rationalreminder.ca/podcast/139
They're generally not a good idea unless you're on 'the inside' and can get early access.
PS: when I say “ask you” it’s part of ESOP contract, the options expire if not exercised.
I sold 2000 options in June. The following April I had to sell 15,000 to pay the taxes on the 2000. The following April I had to sell another 10,000 to pay the taxes on the 15,000.
If I had sold 20,000 instead of 2,000 and used that to pay taxes, I would have been in a far better financial situation.
Fortunately, I never went into the red, but I know people who did.
https://www.latimes.com/archives/la-xpm-2001-apr-13-mn-50476...
The 1M loss is 'capital gains' and therefore a separate category which cannot offset against the 220k income tax bill.
Suppose the stock market has a bad year. You sell a stock or mutual fund and realize a $20,000 loss with no capital gains that year. First, you'll use $3,000 of the loss to offset your ordinary income. The remaining $17,000 will carry over to the following year.
Next year, if you have $5,000 of capital gains, you can use $5,000 of your remaining $17,000 loss carryover to offset it. You can use another $3,000 to deduct against ordinary income, which would leave you with $9,000.
The remaining $9,000 will then carry forward to the next tax year. Assuming that you had no capital gains in the following three years, you could use up the remaining $9,000 loss, $3,000 at a time, over those three years.
[1] https://www.thebalance.com/can-a-capital-loss-carryover-to-t...
The $3000 stacks as an additional deduction from income. But if you had capital gains of $100k, that can totally be offset with a remaining balance of $900k. You can chew away your capital loss carryover with capital gains faster than 333 years.
I'm not a lawyer or accountant so if I'm wrong, happy to learn. :)
[1] https://www.investopedia.com/articles/active-trading/053115/...
His tax bill was way more than his net worth.
https://www.edn.com/toxic-accounting
https://en.wikipedia.org/wiki/Informix_Corporation#Phil_Whit...