What is the best way to avoid paying a tax on the difference between a 'strike price' and the 'fair value price' on a stock?

I previously worked for a Pre-IPO company, when I left I decided to exercise some of the stock options I had earned. (ISO) I do not know when they will go IPO, because of the uncertainty if they will go public, I am looking for some guidance on how to avoid paying too much in next years taxes. I live in California.

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Answered by Dave Bradley, Investment Manager (Financial Advisor) in North Charleston, SC
Hi Anonymously.
Certainly, we can help you with that. We have several folks with these in our PE&VC (Private Equity & Venture Capital) group.

There are 2 types and taxation is treated very differently:
1) Incentive Stock Options (ISO) get more favorable tax treatment and have complex regulations like vesting period, qualified disposition, etc.
2) Non-Qualified Stock Options (NQSO) are taxed when the option is exercised. The tax treatment varies with your tax rate, holding period, etc.

You indicated they are ISO. Is this correct? You also indicated that they have been exercised. Is this correct? If they have already been exercised, check with your CPA on the tax liability.

In any case, we need to know the terms of your ISOs, so send us the terms sheet and/or we can set-up a conference call with your other advisors to discuss in greater detail. If you have an NDA, please let us know this before scheduling a conference call. No obligation.

Some questions for you:
1). Have you met the Qualified Disposition threshold?
2). What about AMT (Alternate Minimum Tax) on the spread?
3. What is your break-even?
4). What would your strike price post IPO be?

There are advantages and disadvantages to both. We really need to both be on the same page with your financial situation and the particulars of the firm (IPO and when, or no IPO and what's in it for you either way).

It's not what you make; it's what you keep that determines your lifestyle
| 06.17.16 @ 22:32
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$commenter.renderDisplayableName() — {comment} | 10.24.16 @ 16:10
Hi - Our state, as you know, is not a tax friendly state to begin with and your situation has a few "what ifs" for me to give you a definitive answer. If your question is only about taxation on the exercise then with ISO's you are required to report the difference between the price at which the options were granted to you and the fair market price at which that you exercised them as taxable compensation for Alternative Minimum Tax (AMT) purposes in the year you exercised the options (unless you sell the stock in the same year, which of course could only happen if this company goes IPO this year, what-if #1).

This is definitely a question for your CPA as they will have all of your particulars.
So you know, ISO transactions can fall into one of 5 different scenarios each of which may have a different tax treatment.

1. Exercise, but hold stock (which at this point in time sounds like where you are).
2. Exercise and sell in same year.
3. Exercise and sell in less than 12 months, but in the following year.
4. Sell stock after one year and a day after exercise, but under 2 years from the original grant date.
5. Sell stock after one year and a day after exercise and at least 2 years from the original grant date.

I can help you build these options into a financial road map as it relates to investing the proceeds for growth, generating current or future income, sheltering from future taxation, etc. This service is complimentary. You can reach my office through the contact links on this website. | 06.21.16 @ 16:11
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$commenter.renderDisplayableName() — {comment} | 10.24.16 @ 16:10
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