Cashless exercise of NSO vs ISO

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MrsRoos
Posts: 82
Joined: Thu Sep 15, 2016 4:14 pm

Cashless exercise of NSO vs ISO

Post by MrsRoos » Wed May 16, 2018 9:08 pm

I've got some stock options (NSO and ISO) expiring soon and I'd like to perform a same day cashless exercise. What are the tax implications for each of these two types of stock options? Will the gains be taxed at my regular income tax rate since it's a same day cashless exercise? Thanks for any advice!
“Anyone who believes in indefinite growth in anything physical, on a physically finite planet, is either mad or an economist.” - Kenneth Boulding

BrainDrain
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Joined: Thu Mar 26, 2015 2:28 am

Re: Cashless exercise of NSO vs ISO

Post by BrainDrain » Wed May 16, 2018 10:15 pm

If by cashless exercise you mean cashless exercise and sale, then there is little difference between ISOs and NSOs. The big differences arise when you exercise options one calendar year and then sell the shares in another year.

With ISOs you will owe ordinary income tax on the bargain between the exercise price and the fair market value of the stock. This is considered a disqualifying disposition, so you don’t get any favorable long term capital gains tax treatment. There are benefits of waiting for 12 months after exercise to sell in order to qualify for LTCG but then you may have other tax issues to worry about including AMT - although this is much less common under the new tax law. Of course you would need to come up with the cash to exercise and hold your options.

With NSOs, the bargain/discount is considered compensation income subject to ordinary income tax. Even if you no longer work for the company, you will owe FICA on the discount as well as ordinary income tax. Waiting to sell shares doesn’t give you the same benefits as with ISOs.

Consider Your Options by Kaye Thomas is a really solid reference for these topics.

kaneohe
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Re: Cashless exercise of NSO vs ISO

Post by kaneohe » Wed May 16, 2018 11:27 pm


evestor
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Re: Cashless exercise of NSO vs ISO

Post by evestor » Wed May 16, 2018 11:33 pm

Can you be more specific about what you intend to do? With that we can better point you at things to read.
Exercise and hold? Exercise and sell?
For the ISOs? For the NSOs? For both?

ryman554
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Joined: Sun Jan 12, 2014 9:44 pm

Re: Cashless exercise of NSO vs ISO

Post by ryman554 » Thu May 17, 2018 9:04 am

BrainDrain wrote:
Wed May 16, 2018 10:15 pm
If by cashless exercise you mean cashless exercise and sale, then there is little difference between ISOs and NSOs. The big differences arise when you exercise options one calendar year and then sell the shares in another year.
I was under the impression that the taxation of both were exactly the same if you exercised and sold on the same day. (I guess I ignored effect of FICA on NQOs...)
BrainDrain wrote:
Wed May 16, 2018 10:15 pm
With ISOs you will owe ordinary income tax on the bargain between the exercise price and the fair market value of the stock. This is considered a disqualifying disposition, so you don’t get any favorable long term capital gains tax treatment. There are benefits of waiting for 12 months after exercise to sell in order to qualify for LTCG but then you may have other tax issues to worry about including AMT - although this is much less common under the new tax law. Of course you would need to come up with the cash to exercise and hold your options.

Consider Your Options by Kaye Thomas is a really solid reference for these topics.
However, I am quite certain that ISO exercise in a buy and hold scheme is a non-taxable event, unless under AMT, and only taxable as a LTCG -- including the purchase/grant spread -- if held for more than a year (and after two years from grant date, which the OP presumably already is).

What you said above is true for disqualifying dispositions, but not true (but, I guess inferred) for a qualifying disposition.

Notice that NQO exercise is always a taxable event -- even if the tax is zero. Sales of both ISO/NQO are taxable events.

BrainDrain
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Joined: Thu Mar 26, 2015 2:28 am

Re: Cashless exercise of NSO vs ISO

Post by BrainDrain » Thu May 17, 2018 11:09 pm

ryman554 wrote:
Thu May 17, 2018 9:04 am
If by cashless exercise you mean cashless exercise and sale, then there is little difference between ISOs and NSOs. Tdifferences arise when you exercise options one calendar year and then sell the shares in another year.

However, I am quite certain that ISO exercise in a buy and hold scheme is a non-taxable event, unless under AMT, and only taxable as a LTCG -- including the purchase/grant spread -- if held for more than a year (and after two years from grant date, which the OP presumably already is).

What you said above is true for disqualifying dispositions, but not true (but, I guess inferred) for a qualifying disposition.

Notice that NQO exercise is always a taxable event -- even if the tax is zero. Sales of both ISO/NQO are taxable events.
OP said cashless exercise, which can only be done as a cashless exercise and immediate sale. There’s no such thing as a cashless exercise and hold thus an ISO disqualifying disposition is a certainty. The money to buy and hold the shares must come from somewhere.

For a cashless exercise, broker lends you money for milliseconds to exercise the options and then you pay back the loan once you’ve sold the shares moments later.

You only have to exercise NSOs once to remember the tax differences on an NSO exercise and sale versus ISO once you’ve paid 7.65 percent FICA, 22 percent mandatory federal tax withholding, and state tax withholding. This even happens if you’ve left the company years ago!

OP it may not make sense to exercise and sell immediately, but there are many considerations on detemining the best course for your financial situation. Taxes and risk are the main ones.

ryman554
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Re: Cashless exercise of NSO vs ISO

Post by ryman554 » Fri May 18, 2018 8:37 am

BrainDrain wrote:
Thu May 17, 2018 11:09 pm
OP said cashless exercise, which can only be done as a cashless exercise and immediate sale. There’s no such thing as a cashless exercise and hold thus an ISO disqualifying disposition is a certainty. The money to buy and hold the shares must come from somewhere.
Isn't there a "sell to cover" option, where you sell just enough to pay the cost of the total option exercise? That's cashless, too. Doesn't work so well if you're not far in the money, but if you're holding a 10-bagger, the single stock risk may not outweigh the tax consequences.

nb: I''ve never had the pleasure of selling ISOs. Only NQOs, and since I moved states between grant and sale, I even messed up the taxes since I screwed up the origin of the money. Fun times.

MrsRoos
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Joined: Thu Sep 15, 2016 4:14 pm

Re: Cashless exercise of NSO vs ISO

Post by MrsRoos » Wed May 23, 2018 1:57 pm

OP here. I'm a little late to respond but thanks for all the input. Brain Drain described it correctly - I had some options that I have not exercised and I would like to exercise and sell on the same day.
BrainDrain wrote:
Thu May 17, 2018 11:09 pm
OP said cashless exercise, which can only be done as a cashless exercise and immediate sale. There’s no such thing as a cashless exercise and hold thus an ISO disqualifying disposition is a certainty. The money to buy and hold the shares must come from somewhere.

For a cashless exercise, broker lends you money for milliseconds to exercise the options and then you pay back the loan once you’ve sold the shares moments later.

You only have to exercise NSOs once to remember the tax differences on an NSO exercise and sale versus ISO once you’ve paid 7.65 percent FICA, 22 percent mandatory federal tax withholding, and state tax withholding. This even happens if you’ve left the company years ago!

OP it may not make sense to exercise and sell immediately, but there are many considerations on detemining the best course for your financial situation. Taxes and risk are the main ones.
I just completed a cashless exercise of my ISO stocks. There was a $19.95 commission (flat) fee to E-trade and the proceeds (gains) I received from the sale will be taxed as ordinary income when I file my taxes next April. As for the Non-Qual stocks, I poked around the E-trade system a little bit and BrainDrain is right. Performing a same day sale on the non-qual stocks will incur $19.95 commission fee to E-trade and taxes withheld (FICA, Fed & State tax), which leaves very little in my pocket. I don't have very much NQ stock, so I think I'll hold on to it for now. It's a gamble, but perhaps the company stock my soar in the next year...
“Anyone who believes in indefinite growth in anything physical, on a physically finite planet, is either mad or an economist.” - Kenneth Boulding

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