I've got some options that I'm looking to exercise and am trying to figure the best way to go about it. I always thought that exercising options and then waiting for long-term capital gains was the way to go - but the math I'm doing doesn't quite add up. Can someone point out what I'm missing?

Note: currently, the company only offers exercise->cash, not to stock. And let's say I'm very bullish on the company in the next year. Tax rates are combined fed & state (CA).

I want to exercise 10,000 NSO options which have an exercise price of $1.

  • Scenario A, market price is $10 @ 43% tax rate

    $100,000 in gross proceeds - $10,000(cost) - $39,307(tax) = $50,692(cash)

    After selling I repurchase stock and end up with 5,069 shares. Wait a year and it increases to $20/share. I decide to sell now at long term rates:

    5069 * $20 = $101,380 with a long term gain of $50,687. 15% tax on that is $7,603 which nets me $43,084 and a complete total of $93,776(cash)

  • Scenario B, market price is $20 @ 45% tax rate (moved up a bracket)

    $200,000 in gross proceeds - $10,000(cost) - $86,782(tax) = $103,217(cash)

It seems that I end up with more money in Scenario B which I didn't expect. Sure I'm paying more taxes, but if I've got more cash shouldn't I be happy? Are my calculations correct or am I missing something?

  • In (A) why are you subtracting the cost when deciding how much to invest in the stock? You never actually incurred that cost, right? (It's just your basis for tax reporting, since presumably you already paid taxes when you were originally awarded the options.) You should refigure with $60,692 invested. Separately, be sure you're using the correct capital gains rate. If you're paying 43 or 45% marginal rate, your long-term capital gains rate is probably 20%, not 15%. – dg99 May 24 '16 at 0:01
  • I definitely incur the cost of the option when I convert it to a stock. And no, I don't pay tax on the option until I exercise it and it becomes a stock. As to tax rate, I was including CA state tax which is 10%, so I'm still in the 15% capital gain tax rate. – holmes May 25 '16 at 14:10
  • Hmm, it might help us (and maybe you'll even discover the answer yourself along the way) to rewrite all the calculations in much more detail. Show every single step. – dg99 May 25 '16 at 15:13

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