Alternative Minimum Tax Complicates Lucrative Tech Stock Options


NEW YORK (MainStreet) — Facebook acquired mobile messaging service WhatsApp last month for $12 billion in stock and $4 billion in cash. That's good news for the app's founders and employees who will be paid $3 billion in restricted stock units. But tax season for WhatApp folks -- not to mention those at FB's recently acquired Oculus VR -- can get complicated because of the alternative minimum tax (AMT), which is a levy of about 28% on adjusted gross income over $175,000 plus 26% on amounts less than $175,000 minus an exemption depending on filing status.

"There are nightmare stories of taxpayers struggling to pay this tax and later selling their shares for much less than the exercise price," said Paul Jacobs, CFP and chief investment officer with Palisades Hudson Financial Group in Atlanta. "For someone who is subject to AMT, this tax break may not be much of a tax break at all."

AMT may be avoided by staying out of the $150,000 to $415,000 income range. For example, a taxpayer might be better off realizing a $1 million capital gain all in one year rather than dividing it into two or three years.

"For early stage companies issue options, we may advise filing an 83(b) election to exercise options before they are vested and before the stock price really ramps up," said Toby Johnston, partner with Moss Adams. "For later stage companies, we may advise a combination strategy of exercising and holding some stock to get long-term gain treatment while exercising and selling other options to generate ordinary income and manage the alternative minimum tax."

The difference between the value of the stock and the exercise price is taxed as ordinary income with Nonqualifying Stock Options (NSOs) upon purchase but with Incentive Stock Options (ISOs) the difference between the value of the stock and the exercise price is subject to the Alternative Minimum Tax (AMT) not regular tax.

Although viewed as windfall income, stock options are earned over time.

"Options are granted at the current fair market value for the underlying stock so they start off with no value but increase over time as the company does well and the price goes up," Johnston told MainStreet.

The benefit is that employees have the option to buy stock that could increase in value.

"If you want to take some risk, you can buy sooner rather than later and potentially reduce your taxes in the long run," Jacobs told MainStreet. "But if you are risk averse, you can just wait and see if the stock goes up and then buy when it does."

The downside is that when an employer grants stock options, they may pay employees less in salary and the price of stock options could fall after purchase in some cases.

As a result, Johnston's strategy is a systemic plan to diversify out of stock options into a broad portfolio of assets.

"The old saying about putting all your eggs in one basket is also true with stock options especially when you consider that you are also dependent on the same company for your day-to-day employment," said Johnston. "Once you decide to sell, you want to try and reduce your taxes as much as possible by qualifying for long-term capital treatment instead of ordinary income."

--Written by Juliette Fairley for MainStreet

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