Options and AMT
/[not legal advice and not accounting advice!]
The first question on most people’s mind when evaluating an options package is how much the value of their employer is going to increase. This is a good question. And it’s fun to think about. You can do some pretty straight forward option math (good summary in this post by Katie Siegel) and see just how much you’ll make. Of course, the IRS wants a piece of that. But who cares, you still made money, life is good.
If, however, you’re concerned about whether the value of your employer will increase, things can be trickier. Not only can the value of your options package go down, but the IRS may still get a piece! Income tax, after all, applies to all gross income, and gross income “means all income from whatever source derived”. It doesn’t matter that the options granted to you are not cash - they are taxable income the instant you receive them. The IRS can issue regulations that postpone taxation on income until there’s a liquidity-producing transaction - and that’s kind of what it did in the case of employee granted stock options. For a good summary of these rules, read this from the National Center for Employee Ownership (thanks to that Siegel post for the link).
It’s only kind of because if you exercise ISOs, you can end up paying a lot in AMT even though you haven’t sold the stock (as in the case of John, at that link). And if you were to hold on to that stock while it goes down (and in the case of privately held stocks, you might have no choice), you’d be in trouble. It happens! And if you were an uber employee who went into debt to exercise your options, this rocky IPO could be extra troubling.
Long story short, keep taxes in mind when thinking about an option package.