Stock Option Tax Planning Moves to Make Before Year End

As we near the holiday season, it’s easy to forget about tax planning with the hustle and bustle of family, travel and (most importantly) pie.

But if you have stock options, making a few quick moves now can make for a pretty present under the tree that will last into the New Year!

Let’s walk through three quick tax planning moves to make before year end!

#1 – If You Have Incentive Stock Options (ISOs), Consider Exercising Options Up To the AMT Crossover Point

ISOs have some interesting characteristics that can make them harder to plan for when compared to NQSOs. One big difference is the impact of Alternative Minimum Tax (AMT). This can be a big “gotcha” if you haven’t planned correctly. AMT tax can apply to the difference between the 409(a) valuation (the current market value of your company’s stock) and the strike price (what you pay to exercise your shares). The larger the difference, the larger potential for AMT tax.

However, there is generally a certain amount of ISOs that you can exercise in a given year without incurring the dreaded AMT tax. This is due to the annual AMT exemption that all taxpayers can take advantage of to shield some of your ISO exercise from tax.

For example, let’s assume a married couple is making $250,000 as shown below. In the first scenario, they exercise and hold ISOs where there is a $50,000 difference between the fair market value and exercise price of the shares. And in the second example, twice as much stock is exercised:

In the first column, there is an additional $230 of AMT tax generated ($38,870 – $38,640). The minimal amount of AMT is largely due to the $126,500 AMT income exemption for 2023.

In the second column, AMT tax grows to $13,230 even though there are no other differences except for the number of ISOs exercised.

It’s important to know how AMT works in your exact situation since there is an interaction between the AMT exemption and your average tax rate. Be sure you’ve modeled this out by using an online calculator or speak to your tax professional before making end of year exercises.

#2 – Triggering or Delaying Ordinary Income on Your Nonqualified Stock Options (NQSOs)

Another potential tax saving available is the decision on when to exercise your NQSOs. Unlike ISOs that can generate AMT when exercised, NQSOs add to your ordinary income and tax in a way very similar to wages and bonuses. Your additional income is calculated as the difference between the fair market value of the stock less the exercise price. This difference ends up in your W2 at the end of the year.

You may wonder why we would intentionally consider accelerating this income into the current year. While generally we like to delay taxes here at McCarthy Tax, sometimes we advise clients of the exact opposite.

Let’s say you were laid off in 2023 and earned half of your salary: $150,000 versus $300,000. Furthermore, it’s taken a few months to get back on your feet and find your dream job making $400,000. If you are single and making $150,000, your marginal tax bracket (the tax paid on your last dollar of income) is likely 24%.

Fast forward to 2024 when you are making $400,000 and now your marginal rate is 35%!

That 11% difference represents a potential tax savings. In our example, you might be able to accelerate $40,000 of income into 2023 and save $4,400!

Taking a quick look at your expected 2023 and 2024 tax situation can pay big dividends.

#3 – Utilizing Capital Losses to Your Advantage

Capital losses occur when you sell a stock for less than your adjusted basis. Your basis in the stock is generally what you paid for it at purchase for non-company stock. 

For options, your cost basis is a little more complicated:

• NQSOs and RSUs – your basis is the value of the stock on the exercise (NQSO) or vest (RSU) date
• ISOs – you actually have two cost bases, strike price for regular tax purposes and fair market value on exercise date for AMT

If you have built up capital losses in past years, these losses carry forward. You can use up to $3,000 to offset other income (good!). The rest just carries over until you have a capital gain (not so good!). Surprisingly, the $3,000 capital loss offset has never been adjusted for inflation and has remained the same since 1976!

While there is a limit on using capital losses against other income, you can use any and all losses up to your capital gains for the year. If you have company stock that you have been thinking of selling and have capital losses to offset the gains, now may be the right time to sell. You could free up cash from the sale to fund your cash goals while not generating any additional tax liability.

The reverse is somewhat true as well. While having a bunch of capital losses isn’t super great, if you need to sell stock or options at a loss, stockpiling these losses for the future will have a benefit down the line. 

Summary

Hopefully these examples have helped you realize the importance of year end tax planning. If you’re in need of additional assistance, we have tax packages available that include this sort of year end planning.

Tis the season for tax savings!