Strategy for selling ISOs

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jedin
Posts: 9
Joined: Sun Dec 02, 2012 11:47 am
Location: Bay Area, CA

Strategy for selling ISOs

Post by jedin »

Hi all, long time lurker since my first posts ages ago. Thanks all for the great information over the years.

My wife's company went public and we could use some advice on selling her incentive stock options (ISOs). Here are the details:

- Current value $1.5m on a cost basis of $40k
- We are close to or in the 37% federal tax bracket and 10.3% or 11.3% bracket in CA
- She elected to early exercise and filed 83(b)
- $40k capital loss carryover from TLH

The vesting schedule is roughly :

- When the lockup expires: $875k (55%)
- End of 2021: $1.125m (75%)
- End of 2022: $1.35m (90%)
- End of 2023: $1.5m (100%)

Some considerations about these options:

- The company stock price has done well. Obviously we can't predict the future but the stock price has settled above where we expected.
- My wife wants to hold some percentage longer term, up to 15%.
- There is a 25% chance that we will move to a lower-tax state and/or take a multi-year sabbatical starting in 2022.

We see the following strategies for selling shares as the ISOs vest:

(1) Sell each share immediately, even if incurring a short-term capital gain
(2) Sell each share as soon as it's eligible for a long-term capital gain
(3) Hold most/all of the shares so they can be sold at a lower tax rates in a different state or just with much lower income

Normally we think (2) is an obvious choice to drop the federal tax rate from 37% to 20%. But with the possibility of (3), does it make sense to hold a large portion to sell later? There's a nice tax benefit there but that's offset with the risk that the stock does poorly over the next 2-3 years. There's also a temptation to "lock in" the higher price by selling earlier -- with the assumption that the price remains somewhat stable until the lockup expires.

Thanks all in advance for your thoughts.
123
Posts: 6408
Joined: Fri Oct 12, 2012 3:55 pm

Re: Strategy for selling ISOs

Post by 123 »

ISOs are very risky, potential gains can be good but can be gone in a flash based on stock and general market conditions. I would cash-out as quickly as you can. Toward the end if you want to retain 5% - 10% of your portfolio in the stock I suppose that's acceptable.

While holding out for long-term tax advantages can be a strategy I would certainly limit that to 50% of less of each award as they become available. But even that represents a large amount of your money on the table that can potentially evaporate.
The closest helping hand is at the end of your own arm.
the way
Posts: 342
Joined: Sat Oct 26, 2019 6:00 pm

Re: Strategy for selling ISOs

Post by the way »

If she early exercised, then it's probably all long term already. By the lock up expiration, will it have been 2 years from grant and 1 year from exercise?

Your taxes on selling will then be 20% + 3.8% + 11.3%, about 35%. Not much you can do about it. It's the cost of success.

(I guess you could be saying that she exercised around the ipo and now has to wait a year to make it long term. Be careful if this is the case since you could still owe a huge amount of AMT tax next year, whether you have sold or not. If you decide to wait the year and the stock collapses, you might owe taxes on money you don't even have.)
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Tamarind
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Joined: Mon Nov 02, 2015 2:38 pm

Re: Strategy for selling ISOs

Post by Tamarind »

Congrats on hitting the rare early exercise jackpot! Your wife took a lot of risk to get this tax benefit and since it has paid off she should sell as they vest. Don't get greedy and extend the risk past what you were aiming for to start with.

Since you are already in the 37% marginal bracket, even if not all the gains are long-term yet I'd say sell the whole first batch at lockup expiration even if some of it is still short term. Presumably the later sets will be more likely to be all LTCG?

Personally I would not keep any as $1.5m is a big enough jackpot for one life for me. But if she wants to keep some (~5% of your total investments) seems like you would be "playing with house money".
milktoast
Posts: 304
Joined: Wed Jul 10, 2019 8:17 pm

Re: Strategy for selling ISOs

Post by milktoast »

Go with #2. Sell as they become LTCG and vested.

Since they are your wife’s shares, don’t argue if she wants to keep some. In fact 15% is surprisingly low, most people are more emotionally attached than that.
mosilaby
Posts: 4
Joined: Mon Sep 28, 2020 8:47 pm

Re: Strategy for selling ISOs

Post by mosilaby »

From the cost basis and the 83b for the early exercise, it sounds like she might have purchased the shares pretty early when the company was small-ish. If she meets the requirements for Qualified Small Business Stock you could pay 0% on the federal LT gains.

The early exercise starts the clock earlier for the 5 year requirement and I assume that means that she technically purchased them early (not when they vest).

If you haven't heard of or researched this yet, it could be a huge tax saving. Your accountant or tax pro should help you.

Some of the big requirements are:
  • Company must be a C corp
  • Shares must have been purchased before the company had over 50M in assets
  • You have to hold the stock for >= 5 years
  • 80% of the value of the corporation’s assets must be used in the active conduct of one or more qualified businesses. (you'll just have to google for this one)

Some links:
https://www.founderscircle.com/what-sta ... tock-qsbs/
https://blog.wealthfront.com/qualified- ... tock-2016/
kxl19
Posts: 104
Joined: Wed Mar 13, 2013 12:41 am

Re: Strategy for selling ISOs

Post by kxl19 »

^^ I also agree that you should check if the exercised ISOs at the time qualified as small business stock. It's an amazing exemption that you should use if qualified. You get 0% Fed exemption if meeting the critera above, and held for 5 years after exercise. Many states also follow this rule, such as MN and CA. I was in a similar situation as your wife (options exercise years prior to IPO, then successful IPO), and I mistakenly sold a chunk of shares about 1 mo before the 5 year mark, not knowing about this rule. That was an easily avoidable cap gains tax.

If the exercised shares are deep in the money, and > 1 year already (sounds likely if it was early exercise), I'd do option #2.

For the options that are maturing soon, it's likely she'll have a 1 year cliff and monthly vesting? (common setup).

If this is the case, I'd suggest creating a "rolling ladder", especially if the vested options are deep in the money.. this enables you to capture value of the LTCG gains, while rolling forward the monthly vested options. Especially important since you're at the top bracket, LTCG is more favorable than paying income-level tax rates on option exercise+sell.

The ladder would be every month..
1 - Sell the exercised shares that are maturing into 1 year LTCG (366 days after exercise)
2 - Every month, exercise & hold the options with deep "in-the-money" strike price.
3 - repeat monthly

You may want to set a dollar or % target to sell every year. Ie- post IPO, sell a chunk that would make you "comfortable" (keeping in mind tax lots, ie, selling lots with LTCG), and then set a % target (ie, sell 10-15%/year). In our case, the post IPO growth was very strong, that % target was becoming too big, so now we set a $ target per year.
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