How can engineers optimize their Incentive Stock Options (ISOs)?
As engineers like ourselves work in the modern world, our total compensation (paycheck) is no longer as simple as a yearly salary amount. Depending on the company we work for, the compensation may include things like Incentive Stock Options or ISOs for short. These are most common in startup companies; those not traded on a public stock exchange. Understanding ISOs can help you better understand how these components may fit into your financial picture.
Let's say we begin working at a company that is in the startup stage. Maybe you've heard the term Series A, B, C, etc. This means the company has gone through various stages of taking on private, outside investors that put up large sums of money to invest early in the company.
Guess what!? You, as an early employee may have the opportunity to participate through an ISO grant. This means the company has granted you the OPTION, but not the obligation to purchase shares of the company for a specific amount. This specific amount is called the strike price.
You're then given a vesting schedule on when you're allowed to take action and buy those shares.
Graded Schedule: Some companies will let you purchase on a graded schedule of X years, most commonly between 1-4 years where you get a percentage of your grant amount available each year.
Cliff: Some companies will let you purchase all of your granted shares at the end of a period. Most commonly 4 years. This means that you would have to wait all four years, then you "fall off the cliff of waiting" and get all of your shares at once.
As you pass your vesting restriction, you're now able to buy your shares. Just like others investing in the company, you have to put your money in to buy the shares.
One potential bonus? You may be able to purchase shares at the predetermined strike price, which may differ from the current market value. For example, if the FMV is $5 today and your strike price is $1, you get to purchase shares valued much higher today than what you have to purchase them for!
BE AWARE of the Alternative Minimum Tax!
The Alternative Minimum Tax AMT is a separate tax consideration built for high-earning individuals. We'll do a deep dive on this later, but the short answer is if you keep the amount of ISOs you exercise in any single calendar year, you may reduce the likelihood of owing taxes up front, depending on your individual situation. Some platforms offer tools that may help facilitate ISO programs, like AMT tax estimators to help you stay under that limit. It's not the end of the world if you do exercise above the limit, but you'll have a tax bill due now rather than when you sell those shares in the future!
The day has finally come! The company is going for an Initial Public Offering IPO or is getting merged with another company that is public or allows the sale of your shares.
There's a few things to consider at this point.
Do your shares have a blackout date? Being a company 'insider' means that you likely can't sell your shares on the same day the company goes for IPO. Instead, you'll have to wait for the blackout period to end before you can sell. Normally 30-180 days after IPO. This ensures that employees and initial investors don't all sell their shares on or slightly after IPO day causing a massive volume of selling early on in the now-public company stock period.
When you sell your shares, ideally for more than you bought them for at the strike price way back when, you may owe taxes on the gain depending on your individual tax circumstances.
If you sell your shares within 365 days from exercising those shares, you may owe income tax on the difference between the amount of money you invested and the amount of money you receive in the sale depending on your individual tax circumstances.
If you sell your shares longer than 365 days from exercising those shares, you'll owe capital gains tax on the difference between the amount of money you invested and the amount of money you receive in the sale. In some cases, capital gains tax rates may differ from income tax rates which may influence timing decisions. Consult your tax professional.*
(Sale Price # of Shares Sold) - (Strike Price # of Shares Bought) -> Gain / Loss * Tax Rate -> Tax Liability (amount owed). This is a simplified example for illustrative purposes only.
Understanding your Incentive Stock Options is a fairly easy thing once we get the basics and those ISOs may be considered as part of the broader financial strategy and planning. Luckily, our amazing team at the Engineer's Financial Group LLC are here to help you through our comprehensive financial planning and tax planning offering available only to the engineering market.
Let's work together so you can Engineer Your Finances!
_______
If you're an engineer and this information resonates with you, we're happy to meet for an introduction on our approach to financial and tax planning for engineers. Best of all, our entire team of advisers and staff are all former engineers!
Visit us at the engineersfinancialgroup.com -> Get Started
This article reflects only the views and opinions of Aaron Gose, ChFC® FSCP® RICP® WMCP® and the Engineer's Financial Group LLC. This article is not a solicitation to buy or sell any securities. Investments involve risk. Consult your financial adviser and CPA for information specific to you.
Aaron Gose, Principal, Financial Adviser with the Engineer’s Financial Group, LLC®, Financial Adviser with Eagle Strategies, LLC, a Registered Investment Adviser, Registered Representative for NYLife Securities, LLC (Member FINRA/SIPC), a Licensed Insurance Agency. Eagle Strategies, LLC and NYLife Securities, LLC are New York Life Companies.
The Engineer’s Financial Group, LLC® is not owned or operated by New York Life or its affiliates. Aaron Gose, The Engineer’s Financial Group, LLC® and its employees, NYLife Securities or its affiliates does not provide tax advice. Please consult your own tax professional regarding your situation.
SMRU 8935036.1