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I'm researching when is best to purchase ISOs I've been vesting at a private venture-backed startup. My understanding is that when I exercise, AMT will trigger and I will have to pay those taxes based on the increase in fair market value compared to the exercise price.

However, it is unclear to me how to calculate what the taxes might be at time of exercise.

I don't know my company's financials, nor do I seem to have access to a 409A (is it normal for this to be available?) so how do I know and how does the IRS know how much to tax me?

Do I need to ask my company very nicely for the fair market value of my stocks to even start to plan exercising?

What if they don't have an up-to-date valuation?
Do I make up a number based on our total funding that I might have to defend later?
Or maybe I'm misunderstanding all of this and I'm probably not going to get taxed anyway?

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    It may just be the way you worded the question, but "I've been vesting at a private venture-backed startup" and "I don't know my company's financials" don't sit well together... I think if I was investing in a start-up, I would need to know their financials. – TripeHound Aug 17 '18 at 6:33
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    I know roughly our revenue and expenses, but not in detail and certainly not enough to calculate a formal valuation of the company. The only number I know exactly is our total funding. From what I've read online, it's normal for startups to be tight-lipped about financials. Surely someone has had to deal with the problem before of determining what their taxes will be at exercise? – user1847319 Aug 17 '18 at 16:56
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I think you may find that this is neither as simple, nor as wise, as you may think. ISOs, or Incentive Stock Options, are granted to employees to convince them to work harder, longer, for a lower salary, to take on extra risk, stay with a company for longer, or as a way to reward individuals who have made particular contributions to the company. They typically vest (not the same as "investing", which I saw in another comment) over time so in order to fully realize the benefit you need to stay with the company for a period after grant rather than leaving and taking skills and specialized knowledge with you.

Because you have stated that this is a private firm, the market for the stock is likely very low. In fact, if all of the stock is held by either the company itself (possibly in a lot designated for awarding ISOs) or by private investors, or if the stock is restricted (which means it cannot be sold or transferred), there may be no fair market value simply because there is no market.

In publicly-traded companies, market value is easily determinable from the current market price for the security, which is usually easy to get.

In a case like this, exercise of the ISO would trigger a transfer of unlisted stock (hence, "private") typically from the company itself, who should provide you with the fair market value at purchase or in tax notifications at an appropriate time. But again, unless there is actually a market for the stock, then there would be no market value.

It might even be that your ISOs are for purchase of company stock "after the company has gone public", when a market value can be calculated. If the company has incorporated, it certainly has stock - but as I noted above, that stock could be limited, restricted, or otherwise not as liquid as you may hope.

  • I will fully vest my options soon, and I am likely to leave the company before IPO. I am required to exercise my options within 60 days of voluntary termination if I want to keep stock in the private company after leaving. I am very optimistic about the future of the company, so I don't think there's any situation that I won't be exercising the options. Ultimately, I just want to know how to know how much taxes I should pay the IRS. – user1847319 Aug 17 '18 at 17:29
  • Not the way ISOs work. Fair market value != open market value. – Kevin Aug 17 '18 at 17:45
  • @user1847319 from the IRS site, it looks like you should get a form from your employer after exercising with (among other things) the FMV on it. If you want to know the FMV before exercising, ask your boss or someone higher up. If you know someone who got options since the last 409(a), you can ask their strike price—that has to be at or above FMV (almost always at). – Kevin Aug 17 '18 at 17:48
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You should ask your employer for the FMV for the purpose of determining whether to exercise your ISOs. They should have this information because they'll need to provide you a Form 3921 with it early next year. Your company is required to provide this information; you should never end up in a situation where you're somehow required to guess at the FMV. Of course, it's possible that the company doesn't currently have a valid FMV, because their most recent valuation has expired. In that case maybe you could use the most recent FMV, take a generous guess about how much that may have increased, and use that as a worst-case scenario for projecting AMT.

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  1. Read the "Stock Plan" or "Stock Option Agreement" or whatever paperwork you had to sign and agree to when you received the options. They typically spells out how this works. It's not fun reading, but its certainly worth understanding what the rules of the game are
  2. For startups, typically the FMV is set by the board once a quarter or so. That should be communicated. The FMV also determines the strike price for new hires, so that's another metric you can use.
  3. The IRS requires any company that dishes out ISO options to keep track of the FMV, so there is no excuse for them to not have this somewhere.
  4. Just ask. Most companies have a stock administrator, who should be able to tackle any questions around this.

Be aware of the RISK. Exercising ISO option will incur an AMT liability. That tax is due next year on April 15, regardless of whether the stock is liquid (can be traded) or not and regardless whether it's down in the dumps or not. You have to pay taxes on virtual gains that may never materialize. That has bankrupted people before. To make it worse: even if you can sell the stock at a decent price, you are still on the hook for regular tax (long/short term capital gains or regular income), so you have to pay taxes twice. This may result in an AMT credit, which is an incredibly complicated and bone-headed tax construct. In other words: it's highly recommended to get professional help and have someone run the numbers before you pull the trigger.

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