When to Exercise Stock Options in a Private Company or Startup

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    This difference is taxed as ordinary income upon exercise.

    And maybe the number is much much higher in your particular circumstances. Or lower. It happens, you know. Or you get sick of working at your company? Or you want to take a sabbatical?

    When the employee sells those shares there is capital gain on the difference between the adjusted basis and sale price. The adjusted basis is generally the Fair Market Value of the stock at exercise.

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    If stock is held for more than one year from exercise, it is taxed as long-term capital gain. If upon sale of stock it is a short-term capital gain, then ordinary income tax rates apply.

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    There are tax issues potential treatment of all gain as compensation related to secondary sales of private company shares acquired by options. Furthermore, there is the question of valuation.

    In order to not be treated as compensation, stock options must comply with rules, including but not limited to, the following: On the grant date, the exercise price must be equal to or greater than the fair market value of the option; On the grant date, the shares subject to the option must be fixed in number; The option must not include any additional features allowing for deferral of compensation or other modifications. A private company will have to set the fair market value of the shares in order to set a price for exercise.

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    Without a traded market in the shares, it can be difficult to determine fair market value. The Section A provides detailed guidelines to determine fair market value.

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    This directly impacts the employees and the employers who could be liable for failing private options withhold proper taxes When a company repurchases stock shares from employees at a premium employer pays more than the fair market value of the sharesthe gain is generally taxed as compensation income and not as capital gain. Further, the use of cashless exercise increases the risk that all the gain could private options treated as compensation.

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    There is also the risk that a repurchase may be treated as a dividend. For more information on the taxation of stock options, please contact our office.

    One is in leverage… and the other one, believe it or not, is in taxes. Leverage as a Source of Return The simple definition of leverage is this: your cost to exercise your options is fixed, but the share price of your company is variable.

    Bowman Law Firm, Gene M. Bowman, Attorney, CPA.

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