It's reassuring that you've independently come to the same conclusion I did.
And in the absence of the NSO option, my current thought on the matter is that they hold no value unless there's an exit while I'm working there, and I'll want to get an accountant who knows how to exercise it all properly.
What are the tax implications of NSOs?
ISOs are a pretty huge gamble, basically a lotto ticket, if you leave before a liquidity event occurs or is known to be on the near horizon.
Many people would prefer the NSO since they don't lose out on vested shares upon departure (or get saddled with a massive tax bill). If you have a good chunk of equity, the outcome can be pretty binary: worth something substantial or basically nothing, in which case the slightly higher tax isn't nearly as important as actually getting a piece.
Folks here are likely talking about employee stock options [NSOs and ISOs]. They've each got their pitfalls, but generally if you exercise them, you immediately owe tax [or AMT, depending--talk to an accountant first!] on the difference between your strike price and the current fair market value. If your employer's public, you know what that value is and can generally sell to cover your taxes. If your employer is private, you need to find out what the FMV is from your employer, and you still owe tax on it [if there's a gain], but you likely have no way of selling to pay the taxes.
It's true that a company can't issue ISOs if the termination window is more than 90 days, they have to be NSOs instead. IMO the downside of the NSOs (pay tax immediately upon exercise instead of at next year's tax deadline - ISOs don't actually change the amount of tax that is due, just the timing of when you pay it) is small compared to the very real risk that your options will go poof if you don't have the cash to exercise and pay tax if there is a termination event.
Is it clear what tax impact the conversion has? Arguably that's the moment when you "vest NSO options", but then the entire tax blow would drop upon leaving the company, which would be particularly bizarre.
(Is the proposed law even clear about how this would work?)
But you have NSOs though, not ISOs right? From what I understand, ISOs are required by law to have a 90 day exercise window, so companies that offer more than 90 days after leaving a company are having ISOs converted to NSOs. When you exercise the NSOs, you still will have a tax bill.
I get this in theory, but there are also tax implications here, and it requires a lot of extra effort. I am not trying to excuse companies from not doing this, but its not as easy as just saying you will.
Options are typically ISOs, but by law, you have a max of 90 days to exercise an ISO after you leave. The only way around this is to instead offer NSOs, which have higher tax implications.
Third, you could offer ISO's, then convert them into NSOs when you leave, but its a lot of extra effort and paperwork.
> If you want to do this with employee options, you have to set up early exercise rights. I think early exercise is done via 83(b) for employees, but I'm not 100% on that.
Yes, if you early exercise ISOs, you would want to file an 83(b) to pay the $0 ordinary income tax burden up front (and get long term capital gains later). I'm not sure if you can file an 83(b) on an NSO.
> Regarding stock options expiring 3 months after leaving the company, it doesn't have to be this way and a lot of startups are moving in the direction of 10 year exercise periods.
This requires converting all options to NSOs, and the tax implications of NSOs are not pretty. (From a tax perspective, ISOs aren't great[0], but they're much better for employees, by design).
[0] You have to pay AMT on the spread between the option price and current value at the time you exercise, whether or not the equity is liquid, so you could end up paying a large tax bill only to find that the company goes bankrupt before you have the opportunity to ever sell your equity.
Even with this, if they're ISOs they'll transfer to NSOs after 90 days. This probably didn't matter before, but the new tax law in the US increases where AMT kicks in from around 120k to 500k.
This means that ISOs can probably be exercised tax free, but NSOs require you to pay taxes on the spread from strike to the fair market valuation.
If your strike price is low enough you may be able to save and afford to exercise the ISOs, the NSOs will probably be too expensive with the tax burden.
There's also a 10yr expiration on options anyway so it's possible that you could lose them even if you're waiting for an IPO while holding unexercised NSOs.
Every year startups get a 409a valuation from an audit firm that determines what their company and shares are worth. The IRS requires that stock options have an exercise price that is equal to or greater than the share price that comes out of the 409a valuation. These are laws, not decisions made by founders/investors.
If you grant stock options with an exercise price that is less than the fair market value (share price from 409a), then that's considered income by the IRS and employees owe tax immediately.
With ISOs, the 90 day exercise window is required by the IRS. With NSOs, it can be longer, like 7-10 years. 7-10 years is obviously way more employee friendly.
my understanding of US stock options for Canadians (and really for anyone who can't afford to exercise their options) is:
- having ISOs is bad, you don't get any of the tax advantages that Americans get and it means that they expire 90 days after you leave the company if you don't exercise them
- having NSOs that expire after 10 years is good, they can still be risky to exercise (same as with ISOs), but that's not too bad because you can delay exercising for 10 years after you get them, and hopefully they'll become liquid (or worthless) before then
- it's possible for a company to switch employees' options from ISOs to NSOs (for example Pinterest did this https://fortune.com/2015/03/23/pinterest-employee-taxes/), so it might be worth putting pressure on your employer to offer that change if you're in the bad (ISO) situation
I've been in that scenario, and honestly I can't imagine why any sane person wouldn't have them convert to NQSOs rather than the true poison of needing to exercise within 90 days. An extremely common scenario:
1. You work your ass off at a startup for years, but even after all those years the company is still not public and the stock isn't liquid.
2. You quit, so you have 90 days to decide if you want to cough up the cash to pay for those options, with no real way to sell.
3. Oh, don't forget the huge AMT bill you'll likely get that year.
4. Pray to God that company is eventually sold for more than all the liquidation preferences of the investors.
Would you rather have that or take the 24-37% potential tax hit (when you can actually sell your shares) vs 15% capital gains.
Also note you can write it so that the decision is totally up to the employee: exercise within 90 days and they're ISOs, after that either lose them or convert to NQSOs.
And for those of you trying to figure out how to report NSO's on a schedule D or a tax program like turbotax - not intuitive at all. Since most employers report NSO proceeds and taxes in your regular W-2 wages and taxes, the schedule D has to show a loss - basically the reported income on that line is a loss because of exercise fees.
You pay taxes when RSUs vest. You pay taxes on options only when you exercise them. In addition, when the RSUs vest, they are yours when you leave the company, with options you have to exercise within a time period (a short one if it's an ISO, potentially 10 years for NSOs).
And in the absence of the NSO option, my current thought on the matter is that they hold no value unless there's an exit while I'm working there, and I'll want to get an accountant who knows how to exercise it all properly.
reply