Is there a future tax benefit to selling RSUs in order to exercise-and-hold the stock options?

Question

I have RSUs and in-the-money stock options granted by my company, both vested. I've held the RSUs for over a year, so I understand that when selling, I would pay long-term capital gains tax on the increase in price since the date of vesting. The stock options are unexercised, so I understand that if I were to exercise-and-sell, I would pay short-term capital gains tax on the gains over the strike price.

Is there a future tax benefit to selling RSUs in order to exercise-and-hold the stock options, which could later be sold under long-term instead of short-term tax rates? It seems to me that there's no additional tax benefit to holding the RSUs longer than a year, but there could be a tax benefit to exercising the options now and holding them, rather than just exercising and selling them at some point in the future. I'd sell the RSUs to get the cash to exercise the options, but that would be done mainly for diversification purposes, since holding onto the RSUs and the exercised options would concentrate too much in one stock.

Am I thinking about this correctly? Is there any additional consideration about what the current or strike prices are, or my future expectations for the stock? It seems that with exercising and holding, I would only pay long-term gains tax and wouldn't pay short-term gains tax on anything at all, but I wonder if I'm missing out somewhere else.

Answer 1

Am I thinking about this correctly?

I think yes, this could be a no-brainer, if:

1. You don't wish to increase your company stock portfolio beyond what you already hold in RSUs.
2. Your options are ISOs.

And possibly also,

3. The amount of ISOs you exercise doesn't trigger an AMT liability.

I separated out #3 because if you would trigger an AMT liability, depending on how the numbers work out it might make sense to just sell some of the new shares in the same year and pay normal income tax on them. I can't really envision a scenario where this helps more than your proposal, but perhaps it would be a wash, in which case it's no longer a "no-brainer".

Is there any additional consideration about what the current or strike prices are, or my future expectations for the stock?

I don't think this changes beyond how you normally choose to invest. If you think the stock would continue to increase faster than an alternative investment you'd consider, then you'd want to increase your total shares rather than hold it constant. One way to achieve that would be to sell only enough RSUs to cover the purchase price of the options and your tax liability, which would increase your total number of shares without any out of pocket costs. And of course, if you have reason to believe the stock is going to tank making the options worthless in the near future, then exercise all your options and sell everything soon, in which case who cares if you pay the higher tax rate on the options; some profit is better than none!

Additional Thoughts:

1. Some people advocate exercising options before April 15 so if you need to sell some shares in order to pay next year's tax bill, you'd be able to sell at the lower capital gains rate. If this is a possibility I'd probably knock that date back a couple of weeks to allow time for checks to clear.
2. Options are oftentimes complicated and each person's situation varies so greatly, that it's usually worth it to hire an accountant to go over it with you. (If you spend a few hundred dollars to end up saving many thousands, well that's definitely a no-brainer!)

Answer 2

I have RSUs and in-the-money stock options granted by my company, both vested. I've held the RSUs for over a year, so I understand that when selling, I would pay long-term capital gains tax on the increase in price since the date of vesting.

Correct.

The stock options are unexercised, so I understand that if I were to exercise-and-sell, I would pay short-term capital gains tax on the gains over the strike price.

No, actually. It depends on what options you have. For ISO you'd pay capital gains rate, if all the conditions are met (including holding periods), so not if you exercise and sell. However, for AMT purposes, ISOs are taxable at exercise, similar to NSO. For NSO you'll have to pay taxes on the difference between the strike price and the exercise price as ordinary income (even if you don't sell the shares).

Is there a future tax benefit to selling RSUs in order to exercise-and-hold the stock options, which could later be sold under long-term instead of short-term tax rates?

How is one related to the other? There's no relationship between the lot you got as RSU and the lot you got from the option exercise. Except, if you sell the RSUs at loss, you may get into wash sale complications by exercising options to acquire other shares.

Whether it makes sense to sell the RSUs in order to get the cash needed to exercise the options, or get the cash from somewhere else and hold the RSUs and the shares you get from exercising the options - is a decision you need to make, but tax considerations here seem to me completely irrelevant. If you think the price will go up and want to capitalize on the capital gains on the exercised options - why wouldn't you want to keep the RSUs and have more gain on them as well?

But consider the fact that by selling the RSUs you're creating a taxable event, and the exercised options will start accumulating the capital gains holding period anew. So you'll pay tax now, and give up potential gains (that you seem to be expecting), yet taking more risk (since you now have short term holding for a while, and you may need to liquidate).